Chapter 6. How Much Should You Save?

OFFERING FINANCIAL ADVICE is always tricky because so much of it is circumstantial. It’s impossible to offer investment guidance if you don’t know someone’s goals, needs, desires, temperament, personality and current financial situation.

In lieu of knowing every reader’s specific personal and financial circumstances, a useful rule of thumb is that your savings rate should be in the double digits as a percentage of your income.

If you do nothing else in your financial life than setting a high savings rate you’ll be alright. Ten per cent is a nice goal while 15% to 20% of your income would be even better. Can everyone afford to have a double-digit savings rate right off the bat? Of course not! But it’s a goal you should work up to if you wish to create a large enough nest egg to reach financial independence someday.

There are numerous benefits that accrue from introducing a double-digit savings rate in your life:

· It gives you a margin of safety when life interferes with your plans.

· It means you have less income to replace once you become financially independent.

· It reduces the many stresses that come as a result of money decisions.

· How much you spend is one of the few areas in life you have control over.

There are a few ways in which you can supercharge your savings to get to a double-digit savings rate over time even if it’s not possible for you right away.

TREAT IT LIKE A BILL

We have a finite amount of willpower, so trying to make it through your monthly budget and save whatever is left over will eventually become a losing strategy. You have to make your savings automatic so you can’t tinker with that decision. Look at saving money like a monthly bill or subscription, like paying for Netflix or a gym membership.

Setting up a direct debit on your personal pension or a Stocks and Shares ISA makes this easy and convenient because you can set this up to leave your bank account soon after your salary is paid in, just like any other bill. Because you never see the money in your bank, in theory you shouldn’t miss it.

Once your saving is taken care of at the start of the month, you don’t need permission to spend elsewhere. You can spend money guilt-free without worry because your savings goals are taken care of. This is a way to think about budgeting in reverse.

Saving money should be prioritised every month just like rent/mortgage, utilities, internet, streaming services and any other regular payments. The goal is to save enough money out of each paycheck that it hurts just a little bit.

WORK YOUR WAY UP TO IT

Let’s assume you want to start small because the prospect of saving lots of money from your paycheck is terrifying. If you save £100 a month towards retirement and your income is £60,000 a year, that’s a savings rate of 2%. To get to our double-digit savings rate goal we have some work to do. Just a 1% increase in your savings rate every year could add hundreds of thousands of pounds to your portfolio over time.

Let’s look at Karen as an example. Karen is 30 years old and makes sixty grand a year, saving £100 a month. If she were to simply keep saving 2% of her income (which grows at 3% per year for cost of living increases) every year until retiring at age 65, she would amass just shy of £260,000, assuming a 7% annual return on her investments.

Now let’s see what happens if Karen were to increase her savings rate by just 1% per year. To hit a 15% savings rate goal it would take 14 years, which sounds like forever. But this allows her to slowly grow into that savings rate. Using the same inputs as before, just a 1% increase for those 14 years and a flat 15% savings rate from then until retirement would grow her balance to £1.4 million.

A 1% annual savings rate increase was worth more than £1 million over the life of Karen’s portfolio.

Again, automate the process as much as you can. If, for example, you’re given the option to increase your savings automatically each year without you having to think about it, then take it.

ACCEPT ANY HELP FROM YOUR EMPLOYER

Some employers will agree to pay more into your pension pot if you agree to increase your contributions to the scheme as well. This is known as ‘contribution matching’. Effectively it’s free money, so whatever you do, don’t turn it down. Most employers will have a limit to the additional contributions that they will match. If you can’t go up to the limit straightaway, you should aim to do so as soon as you can.

AVOID LIFESTYLE CREEP

The ability to witness your friends getting rich or buying stuff without getting jealous is a financial superpower. Lifestyle creep is one of the biggest deterrents to saving money because the more you make, the more you feel you deserve. Making more money can make your life easier, but you must ensure your spending rate doesn’t outpace your savings if you ever wish to truly build wealth.

Let’s go back to our 30-year-old saver, Karen. She still makes £60,000 a year and saves 2% of her salary. Her salary is increased by 3% each year by her employer. Now let’s assume she makes no other changes than saving half of her annual raise every year, thus allowing her to spend the remaining half to improve her standard of living. I call this the save-plus-reward strategy. Saving half of her raise each year would nearly double Karen’s balance on her 2% savings rate from £256k to £433k.

Now let’s take this one step further and see what would happen if Karen saved half of each raise and increased her savings rate by 1% until it hit 15% by her mid-40s. Now by age 65 she has almost £1.6 million.

Starting small and slowly working your way up to your savings goal by avoiding lifestyle creep can provide a huge boost to your retirement savings.

TURBO CHARGE YOUR INCOME

Saving money is important, but cutting back on your spending can only take you so far in life financially. Most financial experts preach the virtues of frugality to get ahead, but earning more money is how you supercharge your savings. The best investment you’ll ever make is in yourself. Negotiating a £10,000 pay rise early in your career could be worth close to £1,000,000 over the course of your career. Here are three different scenarios that show what this single pay increase could turn into if you prioritise it in terms of saving:

Assumptions: 6% annual return and 3% rise each year on an initial £10k rise in salary.

Now think about how much of an impact a few pay rises over the course of your career could have on your wealth if you approach them in this manner. You have to make a concerted effort to save any additional income, but the hard part for most people is actually earning more money.

There are whole books devoted to this subject. But there are two pieces of advice we would urge you to focus on.

HELP TO SOLVE YOUR BOSS’S PROBLEMS

Try to look at things from the perspective of your manager. Most bosses care more about making their lives easier than yours. So ask yourself: what are the problems they face and how can I help to solve them? What work do they do that they don’t enjoy and that I can offer to do for them? Making your boss’s life easier will put you at the front of the queue for a pay rise.

BECOME COMFORTABLE NEGOTIATING

Most people don’t particularly enjoy negotiation – British people especially! But if you want to earn a higher salary you can’t shy away from uncomfortable conversations. So, do your research, believe in yourself and be your own salesperson. Calmly and politely explain why you deserve to be paid more. It has nothing to do with arrogance; it’s about demonstrating value that deserves to be rewarded.

Once you figure out how to get to that goal of a double-digit savings rate you need to figure out where to put that money.