Learning how to save 50% of your income is a great way to set yourself up for financial independence. Maximizing savings is something anyone can do, regardless of income.
Learning How to Save Money
Obviously, I understand that it’s much easier for someone making $100,000 a year to save 50% of their income (and spend $50,000) than it is for someone making $30,000 a year to save 50% of their income (and spend $15,000).
In either situation though, maximizing your savings is possible, and the closer you can get to 50% (or higher) the better off you will be in the long run.
With that in mind, it’s important to be in the right mindset before trying to save a large portion of your earnings. An easy way to do this is to set firm goals. You’ll never accomplish a high savings rate if its a secondary goal, because short term things always come up. Spending the extra $20 to eat out or $30 to go to the movies is second nature when you aren’t thinking of the opportunity cost of that money.
If your main goal is to save 50% of your income, then do that and prioritize that goal.
If your main goal is to retire at age 35, or to save $100,000, or to double your net worth, then put together the plan to get there.
Build Your Budget
In this article, we’ll be walking through exactly how to get to a 50% savings rate, but the same principles and budget outline can be applied to any financial independence goal.
Step 1: Determine Your After-Tax Income
The first step in building any budget is to determine your after tax income. This should include your total income plus any contributions you make to a 401k (this will count towards your savings!).
Step 2: Analyze Your Situation
The next step is to analyze where you stand today. So, break out the pad and paper (or excel doc or use free wealth management software like Personal Capital) and rack up your spending for either the past month, 3 months, or year. The goal is to get realistic view of what an average month of spending looks like. Common expenses could be:
- Other living expenses
- Internet / Cell Phone
- Dining Out
Step 3: Free Up Money Wherever Possible
After determining your after-tax income, and analyzing your current financial situation, step three is to tweak your spending where possible to shift money from your expenses to your savings.
I know, step 3, easier said than done. Let me help bridge the gap. Below is a typical budget, based on a couple budgeting principles (including the 50/30/20 budget and the five category budget), with the percentages being how much of your income gets assigned to each bucket:
- 35% Housing
- 15% Transportation
- 25% Other living expenses
- 25% Savings
Woah, 25% savings, this “typical budget” is already off to a good start!
Adjusting Yourself Into A 50% Savings Rate
Stick with me as we push this even farther. Here are the adjustments you’d have to make to get to a 50% savings rate
- 30% Housing – barely any change, you can live like a King or Queen at 30%
- 3% Transportation – start taking public transportation (or enjoy the cyclelogical benefits of riding a bike and this becomes 0%!)
- 17% Other living expenses
- 50% Savings
How would this play out for an average American bringing home about $40,000 a year in after-tax income? Let’s see (monthly figures below):
- $1,000 Housing
- $100 Transportation
- $566 Other living expenses
- $1,666 Savings
Not so bad when you see an example, right (I hope)? Here’s some more explanation on why this budget could work for you:
- Housing: Average rent in the U.S. is about $1,200, but obviously more affordable cities will be lower. If you want to get to 50% savings, you’ll either have to live in an affordable city or increase your income.
- Transportation: You can get a public transport pass in almost any city for $100 a month (some employers, especially in major cities, will either cover your public transportation costs, or will reimburse you for them).
- Other living expenses: This is a catch all bucket, but includes everything from groceries, utilities, internet, dining out, entertainment and more. Arguably, this is the easiest bucket to pull from in order to increase savings, but also likely has the biggest effect on your quality of life right now.
- Savings: The rest (50%) goes to savings.
Obviously, you would scale these numbers up or down based on your earnings. Or would you?
One of the best things about your income rising over time (again, hopefully) is that you don’t have to increase your standard of living. You could spend more on rent, dinners or groceries, or you could increase your savings rate to 60%. Then 70%. And so on.
It’s completely up to you how to evolve your budget and savings over time.
If you need some further inspiration, here are some easy tips on how to save more money.
Options to Invest Your Savings
Alright, you made it to a 50% savings rate. Now what?
Here are some of the common places to store your savings:
- Emergency Fund: Many experts advise building up an emergency fund of 1-6 months of expenses. This may be a wise first spot to store your savings (a high yield bank account works great) if you are a conservative investor.
- Tax Advantaged Investment Accounts: A 401k and Roth IRAs are great places to invest extra savings (up to the allowable contribution limits).
- Personal Brokerage Account: A personal brokerage account gives you the ultimate flexibility over your investments (there are no limits on contributions or withdrawals). It’s a great place to invest extra savings once your tax advantaged accounts have been maxed out (or before that).
You can learn more about your investment account options here.
Don’t Get Carried Away
I will leave you with one last thought.
Saving for financial independence is great and something most Americans do not do enough. However, not enjoying yourself today in the hope of enjoying yourself tomorrow is also a risky game in and of itself.
If you’re killing yourself to increase your savings rate, you may need to reconsider you original goals you set out to accomplish. Saving only 25% for now may be fine, and when that big pay raise comes your way, you’ll have more money to save later.
The bottom line:
Don’t set a number and get to it at all costs. Set a reasonable goal, strive to get there, and re-adjust your plans as needed. If you are in the saving mindset, that’s half the battle!