How much of my income should I be saving?
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In this economy, making money is tough. Jobs are scarce, hours are long, and pay is cheap. And when you do get your paycheck, every tax person, bill collector, and landlord is gunning for it, dwindling your hard-earned money to mere pittance. But in addition to paying everyday bills and expenses with your paycheck, did you know you should also be saving money?
Fifteen to twenty percent, in fact.
Many experts adhere to the 50/20/30 rule — fifty percent for fixed costs like bills, mortgage payments, and utilities; twenty percent for retirement and emergency funds; and thirty percent so you can enjoy your life.
However, how much you should save also depends on your goals and capability.
"Nobody will ever fit into one box of how much money they should be saving," says Bijan Golker, CFP®, CEO of FPC Investment Advisory, Inc. "If somebody has been disciplined their whole life, they might only need to save two percent based on their goals for retirement. In other cases they might need to try and save more than fifty percent if they got a late start."
Ryan Brown, attorney and partner at CR Myers & Associates, agrees: "People should save as much as they comfortably can afford to set aside. If someone is capable of saving twenty, thirty, or even fifty percent of his income, more credit to him, but even saving just ten percent of one's income is a good number to aim for. The most important thing when it comes to savings is being able to commit to saving a certain percentage every month and sticking to it, regardless of what the future holds."
In order to better understand how much money you need to save, you should ask yourself why you’re saving. Are you saving for vacation, retirement, or a new dishwasher? Are your goals short-term (a purchase to be made in a few years), long-term (a decade or beyond), or both (i.e. the smartest option)?
One the most important reasons to save is to be prepared for an emergency. "Saving is so important because times will not always be ‘good,’" explains Golker. "If you come up with a big hurdle, it is comforting to know that you are covered. If your heater breaks in the middle of winter, you would not need to put it on your credit card. If you have an opportunity come up with a great deal (artwork, car, house, etc.) you will be able to act quickly on it."
You never know when an emergency will arise or where your life will lead. If you're a freelancer, are you prepared for a potentially unpredictable client base and income? If you lose your job or your car breaks down, are you prepared? What if you are diagnosed with a medical condition? Can you afford treatment? Because most experts say your emergency fund should cover at least six months of expenses, will you be able to cover it?
In addition to being prepared for an emergency, there are other benefits to saving.
"The sooner you save, the earlier your money becomes compounded interest," explains Michael Foguth, founder of Foguth Financial. "It’s also important to note that you save for what you want. If you’re saving for retirement in qualified plans, this money will not be able to be touched until you’re typically 59.5 years old. If you are saving for student loans, you’d want to save it in a vehicle in which funds are accessible when they’re needed."
What’s more, saving money can help you avoid the pitfalls of credit card debt. Because the average American has $4,717 of credit card debt, saving money allows you to have extra funds on hand when you need to put something on your credit card now to pay later. Credit card debt means poor credit, and ain’t nobody — car dealerships, landlords, and banks — got time for that.
When it comes to saving money, should you put your money into a savings, a 401(k), or an IRA account?
"Based upon studying the lives of our most successful clients, the best way to save is by first committing to a percentage that you are going to save every month," explains Brown. "Obviously, it's reasonable to assume that the percentage will go up as one begins to make more and more money, but picking that initial number is a good first step. It's best to have money in a savings account and a tax-deferred growth vehicle like an IRA or fixed annuity. Having money in a savings account will bring peace of mind for those unexpected emergencies, while the money in an IRA is more of a long-term savings vehicle since it has more potential growth than a money account or CD."
Golkar also says determining where to save depends on where you’re at in your life. If you’re late to the savings game, an IRA is probably best so you can avoid a near term tax on that income. But if you are young and already saving money, a Roth IRA is a good option. And if you’re a young person saving for a house, for example, you could have a savings account and a traditional brokerage account. Because when it comes to short term goals, putting your money in a CD, money market account, or savings account are all great options. They’re low-risk, accessible, and perfect for short term savings.
Most importantly – when it comes to deciding where to save – don’t forget about taxes. Foguth says that if you’re currently saving in a 401(k), for instance, taxes may increase later on down the road when you’re trying to withdraw the money. With Roth IRAs and Roth 401(k)s, you avoid paying taxes when withdrawing because you pay them when depositing. And if you’re maxing out your 401(k)s and IRAs, consider purchasing cash value life insurance because it has a tax-free cash value, suggests Foguth. Bottom line: If you’re going to focus on saving for retirement, spend just as much time focusing on what the tax implications are going to be in the future when you start drawing that money out.
If you’re still reading this, you’ve probably been convinced that saving money is a very, very good idea. And although saving money can be a daunting task (especially at first) saving is possible. If you spend less, track your spending, download some budget apps, and try your hand at investing, you’ll be saving money in no time.
Saving money provides peace of mind because even though something will always come up – whether it’s a leaky roof or malfunctioning car – it’s nice knowing you have some financial cushion for the blow. What’s more, saving money now can help make your future better later when it comes to college, travel, retirement, and beyond.
Image: American Advisors Group
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