Why Your Savings Rate Matters
When a crisis hits, like COVID, people tend to save more money. As people get more fearful about the future, they are more likely to spend less and save more. As the crisis subsides and recovery takes place, people start spending more and saving less. So, how much should you be saving? Let’s take a deeper dive to help you understand the importance of your savings rate.
Your savings rate is the percentage of personal income saved based on your total gross personal income received during a period of time. A negative rate means you spend more than you receive. So, if you receive $5,000 this month and save $1,000 your personal savings rate equals 20 percent. For those in the accumulation phase, we like to see a 15-20 percent savings rate toward retirement. Your overall savings rate may be more than 20 percent when you include all other savings goals and debt payoff. So why the 15-20 percent savings rate?
The math behind reaching financial independence is fairly simple. By making a few basic assumptions in this case a 5 percent real investment return and 4 percent real withdrawal rate you come up with the following chart.
Using the chart you can see how it works, if you make $100,000 per year and save 50 percent then you only need your investments to provide $50,000 per year in income and you can reach that point after about 16 years. If you save 10 percent then you need your investments to provide $90,000 of income which would require 50 years of savings. For a person that starts working around the age of 18 to 22, saving 15-20 percent each year will help you reach financial independence in 36 to 42 years or between 55 and 65 years old. When you are young, starting the saving habit from day one, doing it consistently each year, and not touching the money is key. As your savings start to add up, working with a financial planner to help you understand all the other items you need to consider will help keep you on track.
It is important to note that the chart and example above oversimplify retirement planning as it excludes pensions, Social Security, tax planning, long-term care planning along with many other factors that should be considered when planning for retirement or other saving goals. The numbers in the chart give you a feel for how important saving consistently over time can be. They also demonstrate how living below your means and on a smaller part of your income helps you save more and reach future goals more quickly. Beyond reaching financial goals, saving money as part of your lifestyle has other significant benefits.
Psychologists have studied the impact of individuals’ financial habits on their overall health and wellbeing for many years. They have found that practicing good financial habits such as having a healthy saving rate will help you experience lower levels of stress.
It is also not surprising that studies have found a link between saving habits and the health of our children. A recent study by UCLA researchers found that children in households with less than three months of savings had a substantially higher risk of obesity and chronic illness and worse overall health than households with more money set aside. Given that children learn the majority of their financial habits from family and friends, it is especially important that we take the time to monitor our own saving habits which will help us demonstrate and teach future generations the habits which will lead to a healthy lifestyle.
Savings rates are something we really enjoy helping clients evaluate and understand. The discussions we have with clients provide peace of mind, promote living a healthy lifestyle, and ensure they pass on positive habits to future generations. This fall is a great time to evaluate your savings rate as you may be surprised at what you find. A few small changes can make a big difference over time, not just for your financial picture, but also for the health of all members of your family.
If you or someone you know would like to set up a time to talk about what we’ve discussed in this blog, please give us a call at (706) 364-4281. One of our financial advisors would be pleased to speak with you.
Clayton Quamme, CFP®
Financial Advisor, Partner