How much do you need to save to have a comfortable retirement? The consensus from the financial industry is you should save 10-15% of your pre-tax income for retirement. Personally, I think this saving rate is too low and this advice is doing a disservice to young people. A new graduate who is starting a full time job will look at this recommendation and try to save 15%. Once it becomes a habit, it is extremely difficult to increase your saving rate unless you make a huge effort to change. Okay, saving 15% will probably be enough to fund a comfortable retirement, but is that all you want? Do you really want to work for 40 years and then retire when you turn 65? Saving more will give you some great options when you’re older. It’s unfortunate that most young people don’t know about the reward of saving more than 15% of their income.
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When I started my first professional job in 1996, my dad encouraged me to sign up for the 401K plan. At 22, I didn’t care about retirement and I wanted to put any extra money in a saving account. This is a terrible way to save because the money is too easy to access and the gain would be very low. Luckily, my dad kept at it and was able to convince me to save for retirement. I started off slow, but increased my contribution to the maximum in just a few years. Consistently maxing out my 401k has been the best financial decision I’ve ever made. That account is the biggest part of our net worth and I owe it to my dad. Unfortunately, I didn’t keep careful track of my finance in those early years so I’m not exactly sure what my saving rate was. It was probably around 25% of my income for most of my 20s.
Anyway, I think 25% is a much better target to shoot for. When you’re just starting out, you have a pretty simple lifestyle. You’re used to living like a poor student and you don’t need a lot of money to be happy. I lived a much nicer lifestyle than when I did in college even with saving 25%. That’s the first reason to save more than 15%.
1. Control lifestyle inflation
Lifestyle inflation gets a lot of people in financial trouble. Saving a bigger percentage of your income from the start will help you control lifestyle inflation. The more you save, the less money you will spend. That’s why it’s the 401k is a great way to save. The contribution is automatically deducted from your paychecks and the money isn’t very accessible. The money just doesn’t feel the same in a saving account. When money is easily accessible, you will probably use it.
Of course, some lifestyle inflation is inevitable. We can’t live like a starving student forever. Well, some of us can, but most of us want to live more comfortably especially as we make more income. I feel that saving 25% or more is a good compromise. If you’re making good income in a white collar job, then 25% shouldn’t be a big problem. Actually, our saving rate kept growing as we increased our income. When I realized I wanted to retire early, I was able to push it into overdrive and saved about 75% of our income during my last 2 years of full-time work. I was saving all of my W2 income and we lived on our other income during this early retirement trial run. This acclimate us our current lifestyle and my early retirement has been relatively smooth.
2. Become wealthy
You will never become wealthy if you save just 15% of your income. You will have enough to fund your retirement, but probably not much more. Of course, the definition of wealth is different for everyone. For me, it means living a comfortable lifestyle and having a little left over to pass on to my kid. Also, I think $3 million net worth is wealthy enough.
Can you become a millionaire by saving 15%? Theoretically, it is possible. Dave Ramsey said you just need to save $35 per week to become a millionaire in 40 years. Of course, in 40 years, a million bucks won’t be worth much.
Saving a bigger percentage of your income is the ticket to wealth for the regular white-collar worker like I used to be. If you can save 25% of your income at the start and then increase it to 50%, you will be a millionaire in much less than 40 years. I estimate 15 to 20 years.
3. More options
Saving more will give you a lot of options when you get older. You may love your job now, but it might not stay that way forever. Saving a bigger percentage of your income will enable you to reach financial independence earlier and you will have a lot more options then. You can continue to work in the same job, but be pickier about your assignments. You could change job or career to something you like better. You could even retire early and become a stay at home dad/blogger like me. The possibilities are endless when you are financially secure.
If I knew about financial independence when I was 22, I’d probably ramped up my saving rate earlier. Those early years make a huge difference due to compound interest. Working for a corporation was fun for a few years, but life is so much better now after more than 3 years of early retirement. Early retirement really agrees with me.
Save more than 15%
Lastly, saving more doesn’t necessarily mean living more frugally. A better option would be to increase your income and keeping your lifestyle the same. We are still saving more than $50,000 per year even after I retired. That’s around 50% of all our income. We have many sources of income now and our investments are paying off. Once Mrs. RB40 retires, then our saving rate will probably drop to near 0%.
My recommendation would be to start saving 25% and try to increase it to 50%. This shouldn’t be too difficult if you just graduated from college and are starting a new job. Your lifestyle will still be much better than when you were a student. It’s much tougher to cut back if you’re already accustom to living a certain lifestyle.
Can you think of other reasons to save more than 15%?
For 2018, Joe plans to diversify his passive income by investing in US heartland real estate through RealtyShares. He has 3 rental units in Portland and he believes the local market is getting overpriced.
Joe highly recommends Personal Capital for DIY investors. He logs on to Personal Capital almost daily to check his cash flow and net worth. They have many useful tools that will help every investor analyze their portfolio and plan for retirement.
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