While most of us have been told since we were young that you should save something every month, most of us are not following that advice. In fact, as of 2017, the OECD reported that the national savings rate in the United States had dropped to a mere 2.9% of GDP, down from 7.5% in 2015. With that in mind, it’s no surprise that over half of Americans have less than $1,000 in savings, and 40% of Americans couldn’t cover a $400 emergency without going into debt.
However, saving should be your top priority if you want to live a life free of money worries. In fact, for most people, saving is the single most powerful lever for financial success — more than smart investments or a steadily increasing paycheck. And the good news: It’s totally within your control.
When you decide to pay yourself first by committing to put aside a meaningful percent of your income each month, you can start your journey to a healthy financial life, and a future full of possibilities. The habit of saving is a helpful skill you can develop to build financial confidence over the years, through life changes and into your old age.
But just how much should you save each month to ensure this secure financial future, filled with nothing but blue skies? First you’ll need to evaluate your goals, your net income, and ultimately, your priorities.
How Much Should You Save?
Financial experts generally recommend that you put at least 10%, preferably 20% toward your savings goals each month. Obviously, this amount will depend on your specific financial situation, as well as your monthly take-home pay.
The 50/30/20 budget is often a good place to start for those just beginning their savings journey, as it provides structured guidance on how to manage your money. Using this method, you first need to determine how much money you actually have to work with each month by calculating your net monthly income.
For a rough estimate, multiply your annual pre-tax salary by your current tax bracket, then divide by 12. For instance, if you make $75K in annual income, you would fall into the 22% tax bracket. The math would look something like this:
[$75,000 – ($75,000 X 22%)] / 12 = $4,875
This doesn’t take into consideration Medicare, other deductions and how marginal tax rates work, but will get you pretty close. If you want more exact numbers, take a look at your most recent paystub or this paycheck calculator.
Knowing you have $4,875 each month in take-home pay, you can then divide your income into the following buckets:
- 50% Needs ($2,437): This category should be used exclusively for the essentials, such as rent, groceries, car payments, insurance, and prescription medications. If you have debt, you should also include minimum debt payments — whether student loan or credit card debt — as those will severely impact your credit score if you don’t pay on time each month.
- 30% Wants ($1,463): This is the fun category that encompasses all those non-essential items that make life more enjoyable. Expenses in this category might include things like entertainment, eating out, shopping, and traveling.
- 20% Savings ($975): This is the amount you should allocate each month towards your savings goals. Ideally, up to 20% of your income goes towards your savings first, and your needs and wants categories are then made to fit into the remaining 80%
As a general rule, the more time you have towards your savings goal, the less money you need to save because you’ll have the benefit of compound interest (your savings earns interest, and the interest you earn also earns interest). The less time you have, the more you need to save each month.
What Are You Saving For?
While the 20% rule is a good guideline, you may need to save more or less depending on your specific goals.
And while we all know — at least in theory — that it’s a good idea to save money every month, many people flounder without a specific goal in mind. Having a particular savings goal can help motivate you to stick to your savings plan and keep you focused so that you don’t get off track when you’re tempted to buy a shiny new gadget.
But what should you be saving for in the first place?
There are several short- and long-term goals that are important to reach if you want to enjoy financial security in the future. To figure out how much you should save each month, you should first determine which goal is next on your list.
Intended to cover your necessary expenses in the event of — you guessed it — an emergency, this is usually the first savings goal for anyone on the path to financial security. At a bare minimum, your emergency fund should have at least three months’ worth of essential living expenses, including your rent or mortgage payments, groceries, and insurance.
For instance, if your minimum monthly expenses are $2,500, you should have $7,500 in your emergency savings account. To feel even more confident, we recommend saving at least 6 to 8 months’ worth of expenses, and up to 12 months’ if you’re the sole breadwinner in your family.
Major Life Purchase
Maybe you’ve already saved enough in your emergency fund to get you through hard times. Now you might be looking to put away some cash for a down payment on a car or house. These are both major purchases that happen rarely in one’s life, so it’s important to be prepared.
To keep your future monthly debt payments manageable, a sizable down payment is typically required. In the case of a new home purchase, it’s a good rule of thumb to pay at least 20% of the purchase price of the home up front, and get a loan for the other 80%. When it comes to cars, we recommend at least a 10% down payment.
While you may encounter tempting offers that allow you to pay less than the recommended amount for a down payment — some lenders even offer 0% down on home and auto loans — just remember that the temptation comes at a cost of higher debt burdens and more interest paid down the road. Saving for a meaningful down payment helps you alleviate that burden.
Rainy Day Fund
Perhaps you know of certain medical or dental expenses that are coming up in the next year, or you’d like to travel to see your loved ones in another state or country. Maybe there are necessary home repairs and maintenance on your house if you’re a homeowner.
Thinking ahead when it comes to future needs always helps with planning for how much you need to save now. To help you prioritize your savings for future “rainy days,” ask yourself if the expense is a “need” or a “want” in order to avoid the stress of finding yourself in a situation where a bump in the road turns into an uncontrollable tailspin.
Among the more worthy savings goals is to put money aside for education in a tax-advantaged account like a 529 plan for college savings. 529 plans allow your savings to grow tax-free, plus withdrawals are also tax-free so long as they’re used for qualified education expenses like tuition, books, room and board while your student is in college. If you plan on having your children attend private school, 529 plans allow payments for elementary and secondary schools (up to $10,000 per student per year) under the 2018 tax law changes.
Your retirement savings, or your “old age freedom funds,” are crucial if you’re to enjoy a comfortable life after you’re done working. However, most Americans are woefully behind when it comes to how much they should have saved for retirement.
But don’t despair, even if you’re behind in your retirement savings, starting now is the best step you can take to secure a large enough nest egg to live comfortably when you can’t or no longer wish to work.
How Do You Find the Money to Save?
Let’s say you have a specific goal in mind, and have now determined how much you should save each month toward that goal. Does it still seem out of reach?
Maybe you find yourself in debt and think you shouldn’t put any money toward your savings goals until that debt is paid off. While it’s absolutely crucial to pay down debt if you’re to enjoy a secure financial future — and it’s definitely no fun to see a chunk of your income go into payments for something you purchased in the past — saving for your future is important too. Financial experts recommend that you pay off high interest debt as quickly as possible, but also put aside a small amount each month — even if it’s just $10.
This may seem counter-intuitive, but getting started with the habit of saving has value in itself. You might find that you will think twice about getting into debt again. You might even get better at prioritizing your needs versus wants, or gain more confidence that you’re taking care of the future you. By starting to save, even if it seems small, it will help encourage you to stick with your savings goals once your debts have been repaid. You’ll already have built momentum with savings, and that’s a good thing to have sooner rather than later.
And if you automate your savings, you might be surprised just how much money you can save each month. Many employers will allow you to divert a certain amount of your income into a savings account. In particular, if you’re saving for retirement, you likely have the option to automatically deduct a predetermined percentage of your wages directly into your 401(k). You can also set up recurring transfers for automatic savings from your bank account to your desired savings account. If you set and forget it, you’re less likely to stray from the plan.
But if your savings goal still seems unattainable, or you wish to decrease the number of months or years until you reach it, there are several other methods to help you make progress. For instance, if you follow the 50/30/20 budget, you could potentially take some of discretionary funds from the “want” bucket to put toward your savings. Alternatively, you could also decrease the amount spent each month on your “needs” category by finding a less expensive place to rent, getting a roommate, or using public transportation instead of having your own car. There are plenty of creative ways to help you save money faster than you thought possible.
Finally, if saving more doesn’t seem possible, try earning more. There are a number of side hustles available that you can fit in around a full-time job. From teaching English, to running errands for Favor, delivering food for DoorDash, or driving for Uber, the opportunities to make a bit of extra cash are numerous.
Where Should You Save?
Now that you know your goal and your monthly savings rate, where should you actually put that money? The answer will depend on whether you need access to your savings in the short-term (e.g. three to five years), or the long-term (more than five years).
For short-term goals such as an emergency fund or saving for a new home, we advise putting your funds in a high-interest online savings account, money market account, or other low risk investments. While your savings may earn lower interest rates — meaning lower growth — you can rest easy knowing the money will be there when you need it.
On the other hand, you can take on a bit more risk with long-term goals, such as education savings or retirement. And as an added bonus, these goals have specific accounts associated with them — 529 plans for education savings, and 401(k)s and IRAs for retirement — so you can rest easy knowing your money’s in the best possible place.
For the simplest way to invest for these long-term goals, you can often find “target date” mutual funds for both education and retirement savings goals. These plans have investments allocated across a variety of assets to deliver the maximum return on your investment within the desired time frame.
For instance, if you’re putting aside education savings for your newborn baby, you can choose an age-based education savings plan that would invest more aggressively — e.g. mostly in stocks — because of the longer time horizon to when your child would begin her schooling. On the other hand, if your child is already 10 years old, another age-based plan would invest more moderately, blending fixed income assets and stocks that pay dividends to better preserve the funds invested.
- Save enough in your traditional or Roth 401(k) to capture any employer match. After all, it’s essentially free money.
- If you can, max out your traditional or Roth IRA. In 2019, the maximum annual contribution is $6,000.
- If you still haven’t met your retirement savings goal, max out your employer’s 401(k). In 2019, the maximum annual contribution amount is $19,000.
It’s important to invest in these specific education and retirement accounts as they’re all tax-advantaged. This means all the gains you make on compound interest grow tax-free, and your money can work harder for you over a long period of time.
Build the Habit of Saving for a Brighter Tomorrow
Many people mistakenly think that millionaires build their wealth from smart investments, market timing, and savvy business skills. While some do, many more millionaires build wealth by saving consistently and meaningfully. None of us can control the stock market or the returns on our investment and retirement accounts, but all of us can control the amount we save.
With a firm savings habit, you can look forward to a life where you have enough saved to be financially independent, without having to depend on others to get you through tough times. One day, you might be able to easily pay for something you want without debt, guilt, or regret. You can look forward to your old age knowing you’ll have your basic expenses and medical bills covered. And who knows, you might even be able to retire early if the habit catches hold.