How much of your Salary should you save?

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27 March 2019

How much of your Salary should you save?

It is believed that living well and achieving dreams like buying a car, travelling or buying a home require quite a bit of financing as well as financial planning. Saving a bit of your income each month goes a long way if you wish to lead a comfortable life and be prepared for emergencies like losing or quitting your job, or a sudden medical problem. This brings us to the question on everyone’s mind these days – how much of our salary should we save per month? There are several ideas regarding this, but a lot of them stem from the one popularized by American Senator Elizabeth Warren, called the 50/30/20 rule. However, it’s not the only one. Here are some ideas on how to go about keeping aside some of your income as savings.

The 50/30/20 rule

Simply put, the rule suggests that:

  • 50% of your income must be channelled towards your “needs” – essential items that we can’t do without – like food, rent, electricity, etc.
  • 30% should be spent on your “wants” – non essential items but desires you’d be happy to fulfil.
  • And 20% should be put into your savings.

This 20% can be split between retirement savings, an emergency fund and investments, including mutual funds, SIPs, stock market investment, etc. Savings could also indicate debt repayment, as any interest payment would reduce future debt. This rule can’t really be applied everywhere, especially if your salary is too low, or if your financial goals require you to save more. However, it is an excellent guide for someone who doesn’t know how to start saving.

Rules for retirement savings

One of the most popular rules of thumb when it comes to retirement savings is to put away 10% of your income every month. Most careers have a retirement age, that is, when you turn approximately 60, you’d probably want to (or have to) stop working. However, your basic needs and wants are unlikely to reduce after you stop working. In fact, your standard of living would’ve risen signifiacntly over the years, making it more expensive than ever before. Plus old age can bring with itself health problems, which invariably leads to more expenses. Saving a certain amount, specifically for when you retire, is a good idea.

10% of your monthly salary is a good start, especially for youngsters who have just started out. However, if you start late, you’ll probably have to put more of your income towards your retirement. You could put the money in a retirement fund, or according to the returns, invest in some long term mutual funds. Another approach is to save money considering that by the time you retire, you should have 20 times your annual salary saved up. This is a more comprehensive approach than that 10% rule, as you can save a particular amount depending on when you start saving.

Emergency fund rule

A popular belief is that you should have enough money stored up in an emergency fund to last you between three to nine months. The fund should cover your living expenses for this time period, including food, rent, any debt repayments, health requirements, etc. This is usually in case you suddenly find yourself without a job, so there is no need to include costs for entertainment, dining out and other things you would indulge in otherwise.

Although three to nine months’ worth of money is often not enough, as you may be out of a job for longer, it helps to know you can at lease survive for so long without a steady salary. It is, however, believed by some that it’s unwise to keep so much money in a savings account when it can be invested for higher returns. Others argue that this fund is not necessary at all. Of course, if you don’t have this money stocked up and need money urgently, you can also apply for instant loans or a salary advance through apps like EarlySalary to get you through for the time being.

The money ratios approach

Charles Farrell, in his book “Your Money Ratios”, suggested an approach to calculate savings rate considering age, current income and current savings:

  • According to him, you need to accumulate 12 times your annual salary by the time you retire.
  • Assuming that your invested money will give a return of about 8% annually, you can live on about 80% of your annual income even after you retire.
  • He also suggests that you put the money you’re keeping aside in a retirement account, or invest it somewhere which will give you good returns at low risk.

Of course, all these rules are subjective and only serve to provide a set of guidelines to work with, when you don’t know how to start saving. Before following any of these rules, it is recommended you first look at your financial goals. If, for example, you wish to buy your first car in ten years without a loan, you need to start saving up for it accordingly. Calculate how much you need to invest per month, and estimate the returns you must get through your investment over ten years in order to buy the car. The approach is similar for any financial goals you may have. But putting away a small amount towards your retirement and keeping some money aside for emergencies are two things that must not be ignored.

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