How to Leverage Your Savings Rate to Keep Expenses in Check and Reach Your Goals
I recently met a good friend from college for dinner. We hadn’t seen each other in a couple years, so I was really looking forward to catching up. As expected, we kicked off the first half hour or so with the usual life updates: work, relationships, our families, etc. However, what I wasn’t expecting was that we would spend the remaining hour and a half of dinner talking through my buddy’s most burning financial questions. We covered a ton of topics in our time together, but there was one looming question he seemed to keep coming back to: “How do I know if I’m on track with my saving vs. spending?”
When it comes to building wealth as a young professional, there are many variables that come into play. Some of these factors are perfectly within our control, but the reality is, many are not. For instance, we can’t always be in complete control of our salaries or pay raises, nor do we have much influence over what tax laws congress passes or how the stock market performs. What we absolutely can control, though, is how much we save (and spend), and having an intentional savings rate goal can be incredibly liberating financially, mentally, and emotionally.
Budgeting – Is it truly a necessity or just another item filling up my to-do list?
Detailed budgeting can be a very valuable exercise when done periodically. Most importantly, it can be useful in helping you discover where any unnecessary spending might be happening. However, if you’re like me, you might not always have the time or desire to track every expense and reconcile them with your spreadsheet. You’ve also probably come to realize that life has a tendency to get a little crazy at times, and there will be some months that require you to spend more than others. For those reasons, I’ve often found budgeting to be more stressful than anything else.
On the other hand, I prefer to use my savings rate as a way of automatically – and relatively effortlessly – keeping my spending in check. By setting up automated contributions to my 401(k), Roth IRA, and other accounts, I feel like I’m able to quite literally give myself permission to use the rest of my money to do the things that bring me fulfillment, guilt-free. So long as I’m able to pay my credit card bill off each month (make sure you do that, by the way!) without tapping my savings, I can have total peace of mind that I’m building towards my long-term financial goals because I’m always paying myself first.
So, what savings rate should I shoot for?
As you might imagine, the amount someone can and should save will differ greatly depending on a number of factors - how old they are, how much money they make, their non-discretionary expenses, their personal goals, and so forth. With that said, a general rule of thumb I like is to aim to save and invest at least 20-25% of your gross income (before taxes). Ignoring the actual numbers for a second, one of the things I love about this guideline is that it uses percentages instead of hard dollar amounts, so it’s easy to apply, regardless of how much money you make, and can help ensure you’re saving enough to maintain a comparable lifestyle in retirement.
As a quick example, in the case of someone who makes $150,000 per year, they might look to contribute at least $30,000-$37,500 throughout the year to their investment accounts (combined). Conversely, someone who makes $300,000, following the same rule of thumb, would aim to save $60,000-$75,000 per year. Keep in mind that saving more than 25% is perfectly fine, and the higher your income, the easier it will likely be to exceed that threshold. Either way, 20-25% should serve as a good starting point for a majority of young professionals who want to be responsible with their money and still be able to enjoy life along the way; however, it will probably make sense to engage a professional at some point to see if this makes sense for your personal goals.
Time = Your Most Powerful Wealth-Building Tool
As wealth management professionals, we hear over and over from even our most disciplined clients, “I only wish I had started sooner!” One thing that can never be overlooked when discussing saving and investing is the importance of time to allow for compounding growth. In fact, the earlier you’re able to set your savings rate and start building your wealth, the less you’d actually have to contribute to reach your long-term financial goals vs. someone with the same goal who starts just a few years later.
Albert Einstein referred to compounding growth as “…the eighth wonder of the world. He who understands it, earns it; he who doesn’t, pays it.” The earlier you’re able to establish your savings rate to easily control your expenses and get your money working for you, the sooner you’ll reach financial independence and have even greater ability to live life on your own terms.