Saving is one habit that lets your boat sail in the rainy days. But are you saving enough? How much do you need to save to be relaxed? We all stumble upon these questions, but we hardly plan on it. Read on to find out.
We all know that saving is important. But, should you be saving ₹5,000 or ₹10,000 is the question? How do you arrive at this magic number? Well, there is a magic number which is 20%. You must be saving at least 20% of your EBIT to have a relaxed retirement.
Why is 20% the magic number?
In 20’s and 30’s you can earn an average of 5-6% a year post-tax. And, if you are determined to save at least 20% of your income, you will have a good amount to retire with and enjoy the financial independence before you are too old. To learn about top investments of 2016 click here
Fidelity Investments have a view that when you plan to retire, you must have 10X of your final salary, and that can happen if you start young.
|How much should the savings clock trigger?|
|1 x salary by the age of 35|
|3 x salary by the age of 45|
|5 x salary by the age of 50|
|8 x salary by the age of 60|
|10x salary by the age of 67|
There are times when you will have to make adjustments, but this is the rule of thumb that will guide you to the goal.
Be clear on your goals:
Make a list of things that you want to achieve, or the reason why you are saving, and save money accordingly. Spending is way easier than saving hence, you need to be committed. Your goal reachability would also depend on how well your investments perform. Hence, you need to choose the right mix of debt and equity investments.
So, the equation is that you spend 50% of income on your essentials like (rent, food, bills etc.), 30% should be on lifestyle (car, night outs, travel) and 20% should be saved.
What if I have high-interest debts?
Clearing the debts off should be the first thing in mind. If you have some outsized debts like credit card payments, student loan, vehicle loan etc. the interest of it will eat up all your savings. Hence, try to clear them as soon as possible. You need to plan in such a way where you are spending a little less on lifestyle, till the time your debts are cleared. But, even in this scenario, I suggest that you should save at least 5% for your emergency fund. The expense of 50% is something that you have to do as it is on essentials but, you should tweak on the rest.
What if I am unable to save 20%?
It is ok! No one can start straight away with the 20% figure, they rise slowly. Start with 1-2% and then gradually increase to 10, 15 and 20. Try to see how much can you stretch. Will you be able to save 30% a month? Try different permutation and combination. See what suits you the best and adhere to it.
I have hit the 20% savings goal, what now?
The ultimate fantasy… Living off your interest income
Say for example you withdraw 4% of the principal amount and live on it for the rest of your life, which will mean that, you will have to save 25 times your expense to meet your needs. (25*4=100% of your principal amount).
If you save 25 times your annual income today, you will be saving more than you need. And, you can simply withdraw your interest and live on it for infinite years. Let’s be conservative and assume that your investments grow at 5% per annum. Look at the chart below to know how much you need to save
How much should be the rate of your savings?
|% of income to be saved||Time needed to save 25x of your income|
This chart assumes, that there are no prior savings.
So, if you save 20% of what you earn in another 41 years you can retire. Trust me it is not as bad as it sounds. All you need it to start early and increase the rate of savings as and when time permits.
What if you hit the 20% mark of savings easily?
If you have met this goal easily, you might want to look into any financial decisions like buying a home or maybe owning a car. If all your needs are already met then try increasing the percentage of savings for an early retirement.