It’s common financial sense to save money, right? That’s all well and good, but just how much money should you be saving? That’s a question that doesn’t get answered as much, although it’s probably asked more times than, “Hm…is saving money even worthwhile?” (Of course it is!)
If you’ve ever wondered how much of your paycheck to save, there are a few methods you can follow to figure it out. Choose whichever one works for you. As long as you’re saving money, you’re moving in the right direction by increasing your net worth.
Method #1: Save 15-20 percent
The simplest rule of thumb to follow is to save 15-to-20 percent of your net income. That means if you earn $50,000 per year after taxes, you should aim to save between $625 and $833 per month (out of $4,166 per month).
That may seem a little out of reach for you right now. Perhaps you’re dealing with student loan debt, credit card debt, or trying to pay rent and bills on a low salary.
That’s okay, just modify it and work your way up! Start by saving five percent of your income each month. When you’ve got that down, try saving 10 percent.
The worst thing you can do is go for it all at once and burn yourself out trying to save more when you’re not used to doing so. 15-to-20 percent is generally recommended because it’s enough for you to work your way toward a safe retirement.
If your goal is to achieve financial independence, you might want to save 50-to-70 percent of your income each month. Yep, that much of a bump will likely shorten the amount of time you need to work by about 10 years!
Also, remember that if you have an employer match for your 401(k), then you can easily double your savings rate. Tax refunds and windfall money can help as well.
Method #2: Work backwards
The above method greatly oversimplifies things. The basics are okay for the beginning of your financial journey, but your car is going to need a little more gas to get to its final destination.
The best way to plan for how much of your paycheck you should save is to work backwards. Think about what your ideal retirement looks like, and how much you’d be comfortable spending each year. This takes a bit of planning and forward-thinking, but it’s worth it to get a more accurate picture of how much to save.
For example, say you calculate that you’ll spend $45,000 per year in retirement. According to the popular “rule of 25” (or four percent withdrawal rate), you’ll need $1,125,000 saved up to afford that. $45,000 x 25 = $1,125,000, or $45,000 / .04 (rate of inflation) = $1,125,000.
Method #3: Max it out
Don’t want to bother with the math? Put your savings on autopilot by setting a goal to max out your 401(k) and IRA to supercharge your savings. Following these guidelines makes it easy to figure out how much you should save.
As of 2016, you can contribute a maximum of $18,000 toward your 401(k) and a maximum of $5,500 toward your IRA. Combined, that’s $23,500! You’d be well on your way to an early retirement if you could manage to save that much.
This method clearly isn’t for everyone, but if you have the means, take advantage of the compound interest and tax advantages you receive from contributing to a 401(k).
What’s your saving goal?
After running all the numbers, you might be left wondering how to balance all your savings goals. Luckily, we already covered that here. To give you a quick breakdown, your savings priorities should look similar to this:
- Emergency fund (around $500 to start)
- Short-term savings goals (generally smaller; a new laptop)
- Long-term savings goals (generally larger; a home)
- Retirement weaved in (this becomes your number one priority once you’re in your late 30s, early 40s)
Feeling overwhelmed? You don’t need to drive yourself crazy tackling all these things at once. Take it one step at a time, and save as much as you need to so you can achieve your financial goals.
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