The New Savings Rule of Thumb
How much of your income should you be saving?
A common rule of thumb answer used to be that 10 percent of income
should go into savings.
"But 10 percent of income is a lot!" is a common
response. Saving that kind of money seems so daunting that most
people don't even try, which is why the national savings rate
ended up actually being negative in the mid-2000's. Today,
consumers are spending less and saving more, but the national
savings rate is still in the low single digits - well below the 8
to 10 percent rate in the 50's and 60's.
10 Percent Is Not Enough
Here's the real kicker: based on recently published research,
the average savings rate really should be 16 to 20 percent of
household income... not 10 percent.
Sixteen to 20 percent?! Ouch!
If 10 percent was so difficult that most Americans didn't even
try, how likely is it that you will take a shot at 20 percent
savings? It's almost too depressing to think about.
Mission Impossible
Hang with me for a few more minutes, though, and let's see if
we can make a dent in this seemingly impossible 20 percent savings
target.
As a Certified Financial Planner™, I've reviewed lots of client
cases over the years. Since I believe true wealth is built out of
cash flow management (not investment management), I have paid
closest attention to the successes and failures of various savings
strategies.
Here is what works:
Step #1: Trim the Fat
Almost everybody can identify 5 percent in cash flow savings just
by paying attention to expense details. Use an online budget
planner to chronicle every dollar that you spend.
When you see an expense you don't recognize or is surprising,
you will have found an easy place to
trim your expenses. Spending your money on that item obviously
didn't register as much of an experience. Otherwise, you would
have remembered it.
Step #2: Understand Value
Take a moment to think about the most important things in life to
you. These are your values. For most
people, top tier values include relationships, family and special
experiences. They almost never include “stuff” (i.e. tangible
items). Humans are hard-wired to be attracted to shiny new things,
but that attraction doesn't last and the item is soon
forgotten.
Here's an example: remember the new shirt you "had to
have" back in 2002? Me neither. Same thing goes for most
restaurant meals - they just aren't that special to
remember.
In the grand scheme of things, the phrase, "He who dies with
the most toys wins," is rarely what's going through the
mind of a person on their death bed.
Step #3: Pay for Value
Every time you are faced with a spending decision, take a short
pause to ask yourself, "Is having this really important to me?
How important is it?"
Compare your answers to how important having something different
that you would really treasure would be in your life. Understand
that every dollar you spend on one thing is a dollar that cannot be
spent on something else that you might value more.
Step #4: Shift Your Framework
The last trick is to change the perspective with which you view
each purchase decision. Our tendency is to view expenses in
comparison to our annual personal income: "I make $40,000 a
year. This is a $20 purchase. Twenty bucks is nothing compared to
$40,000, so the cost is insignificant." Or, "The cost is
zero and I want it."
When your brain does the cost-benefit analysis - you end up making
the purchase.
But what if you compared that $20 purchase decision to the money
you REALLY have control over. For most people that "control
income" ends up being $100-150 per week for everything
including food, clothing expenses and entertainment - truly
discretionary expenses. The rest of the money you spend each week
is to pay taxes or fulfill previous obligations like rent or
mortgage, utilities, loan payments and gas for your car.
Now that the $20 decision IS significant (compared to $100 you have
to spend all week), you might be tempted to think twice about
dropping the cash.
You Can Do This
Implementing each of these four steps can easily trim 10 to 15
percent of your current expenses without giving up anything that is
really important to you. You're just spending less money on the
stuff that doesn't matter anyway.
I have seen many cases where clients have actually been able to
exceed the 20 percent savings rate target and in every case they
have said they have never been happier.
