More than your income and investments, saving is the most important thing you can do to grow your wealth. But how much should you save each month? Half your salary? £100 a month? Or nothing until you have paid off all your debt?
How much should I be saving each month?
Okay, as always, with saving there is no ‘one-size-fits-all’ number for how much you should keep back each month. Individual circumstances are a key factor… However, as a general rule the amount you should aim to save is 20% of your salary.
This number comes from the popular 50/30/20 rule. 50% to pay for rent, bills, shopping etc. 30% on discretionary spending (Eating out, socialising etc), and 20% into savings.
Why Save 20%?
This is based on research that found if you are in your 20s or 30s and you can on average earn a return on investment of around 5% each year, then you would need to save 20% to be able to achieve financial independence at an age where you can still enjoy it.
Obviously if you are a high earner you should try and save as much as possible. Likewise, if you are a lesser earner and trying to save 20% would dramatically impact your standard of living, then of course try to save 15%, 8% or even 1%. As any saving amount is better than nothing at all.
What are you saving for
In a word…independence. Independence from the rat race, and having to exchange your time for money, so instead, you can spend your days doing the things you love. Whether that be a passion project, travelling, or simply spending more time with your family.
This independence would be sustained purely from investments, interest, and dividends.
How long would it take to achieve this?
This depends on how much you are able to save each month. But for argument’s sake, let’s use the 4% rule.
The 4% rule states that you can withdraw 4% of your principal balance each year and live off of this indefinitely.
Using this as a benchmark you would need to save 25 times your annual expenses to become financially independent (25 x 4 is 100%, and 100 is your total balance).
How much are my annual expenses?
This is of course something you will have to work out, but of course the less money you think you need the better. As it means you will be able to hit the amount much quicker.
One thing to keep in mind, is that currently your salary is heavily taxed, and you are also factoring saving into your monthly budget (or at least you should be!). So if you take this into account then the amount you are living off is actually less.
How long will it take to reach my target?
So for example, say you are currently on £35k a year, when you factor in the tax you pay, you are only taking home £27k. Then if you take off the amount you put into savings (assuming this is 20%), the total comes down to £21,600.
Taking this example, you would need to accumulate a savings pot of around £540k to achieve financial independence.
To get an idea of how long it will take you to reach your savings goal. I have created a simple spread sheet you can download and fill to get an estimation. Available here.
Simply make a copy of the document and fill in your current savings, how much you want to try and save each year moving forward, and what interest rate you are aiming to achieve.
Where should I put my Savings to Achieve this Goal?
When planning for long term growth, Mutual Funds and Index Trackers give great returns. They obviously have some risk attached to them, but If you are leaving the investment for more than 5 years that should be enough time to ride out any dips in the stock market.
If you are leaving your investment to grow over 20+ years then you can afford to invest in some of the higher risk/reward Funds. On a good year these Funds can grow upward of 20% which would significantly reduce the time it takes to reach your saving target.
For a closer look at what funds are best for you, and help picking, i’d recommend using this free tool on the Hargreaves Lansdown site.
Avoid putting all your money into long-term investments
Although Mutual funds are great to increase your asset growth, you don’t want to be forced to sell your holdings prematurely.
For example, if you put all your money into Funds, and then you’re hit with a massive car repair bill, you would have to sell some holdings to pay for it. If this happens when the stock market is down, you could be forced to take that money out at a loss.
To avoid this, I would always recommend keeping some emergency money in a normal bank account. This enables you to see off any unexpected costs, without touching your long term investments.
How much you keep aside for emergencies is up to you, but I aim to have the equivalent of one months salary. When I dip into my emergency pot, I always ensure I fill it up again before making further investments.
Want some tips on how you can save more money each month? Check out our article 7 Ways You Can Reduce Spending and Save