How Much Should You Save?

Save until it hurts, it will benefit one of your most favorite people. This question is much more complicated than it appears on the surface because it depends on a number of variables. Major factors include; personal objectives, age, time to retirement educational funding needs, desire for wealth accumulation, need for special tax treatment, current wealth, current income, and the list goes on. The actual amount of your saving may be influenced by any or all of this information. The first step is to prioritize your objectives. The second is to attempt to quantify those objectives. And lastly, determine the availability of funds to meet those objectives.

Take the example of a person in their early twenties, unmarried, starting their first job, earning approximately $35,000 annually. Personal objectives are probably pretty fuzzy at this point in their investment life. If this individual can initially save between 1% to 5% they will be doing well. The next question becomes where and how should this investment be made? Experience and knowledge would seem to indicate that beginning to fund a retirement objective is of primary importance. Contributing $30.00 (1% of gross income) per month appears to be a reasonable amount. Each time the individual receives a salary increase raise the retirement contribution by 50% of the amount of each raise. Reasonable retirement contributions would be as follows:

  • Age 20 to 35 Contributions increasing from 1% to 10% as earnings increase

  • Age 35 to 45 Contributions increasing from 10% to 15% of gross wages

  • Age 45 to 50 Contributions increasing from 15% to 25% of gross wages

  • Age 50 to Retirement Contributions of 25% or more of gross wages

One exception to the above is individuals should always attempt to contribute to the maximum level of employer matching contributions.

Once the primary objective is implemented other alternatives can be examined. Funding an education program for your children may be the next most important objective. There are basically two programs available: Qualified Tuition Plan (529 program), and Coverdell program. The earlier these contributions are started the more achievable the objective becomes. A $250,000 college expense would require an annual saving of approximately $5750 earning a 7% return over a period of 20 years. A combination of these programs can be used to pay for both elementary and secondary education at a private school and college education expenses. It also bears mentioning that grandparents may also contribute to these accounts for their grandchildren.

Once a person reaches 50 years of age there is a good chance their children are out of school, the mortgage is paid off etc.. Now is the time to redouble your savings effort and expand your retirement savings. If the pre-tax contributions to retirement accounts have been fully utilized then contributions can be made to a ROTH IRA which will generate tax free income during retirement.

Individuals who have accumulated sufficient wealth and do not need additional retirement income should concentrate on preserving their wealth by taking less portfolio risk. A good rule of thumb is to determine your food, clothing, medical and shelter expenses (living expenses), subtract that amount from after tax income to arrive at a disposable income amount. Divide this amount in to two equal parts, one for hobbies, entertainment and the like and the other 50% for savings. This strategy will allow your portfolio to continue to grow and provide some inflation protection.