What proportion of your income should you set aside for savings? The 50/30/20 guideline states that you should save 20% of your income. But it isn't always that easy.
Your personal saving rate, more than your income or investment returns, is the most important component in achieving financial security.
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But how much money should you put aside? How about $50 a month? 50 percent of your take-home pay? Nothing until you're debt-free or able to start earning more?
Many experts recommend putting aside 20% of your monthly salary.
The popular 50/30/20 guideline states that you should set aside 50% of your budget for necessities like rent and food, 30% for discretionary expenditure, and at least 20% for savings.
We generally think that saving at least 20% of your monthly income is a good idea. However, recommending the appropriate amount of income for YOU to save isn't usually that straightforward.
True financial independence entails having enough money to avoid ever working again. For the remainder of your life, you can live off your current savings plus any growth, interest, or dividends.
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How much money do you need to save in order to accomplish this?
The short answer is that it depends. It all depends on whether you're willing to live on the edge of poverty, require two homes and a sailboat, or fall somewhere in the middle. It also depends on the performance of your investments. If you can generate a 7% average yearly return on your money, you can retire with a lot less money than if you only earn 3%.
For the sake of simplicity, we'll apply the well-known "4% rule," which claims that you could potentially withdraw 4% of your principal balance every year and live on it indefinitely. To become financially independent, you will need to save 25 times your annual expenses. (If the math doesn't add up, remember that 25 x 4 equals 100, and 100 percent equals your total balance.)
Of course, there are flaws in the 4 percent criterion. For starters, there are currently no risk-free investments that yield anything near 4%. Inflationary shocks could potentially be a problem.
Furthermore, if your investment returns are better than 4%, you are living on less than you should and your account balance is increasing year after year. That's a nice problem to have, but it suggests you're leading a less-than-ideal lifestyle.
Bottom line: everything carries risk, and assuming a rigorous 4% withdrawal rate could result in either not having enough money... or consuming far too much.
I think it's a good idea to plan around a 4% withdrawal and then make modifications as needed when the time arrives.
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