What Experts Say About How Much to Keep in Savings
This is one of the most widely searched questions related to the personal finances of the past two decades. The answer is $42,118. If you don’t have that, you’re pretty much doomed. No point even trying at this point.
Thanks for reading. See you next time.
No, no, no. Obviously, that’s not the answer. There is no answer – not one, simple, single answer, anyway. There are some pretty good guidelines to consider, however. THOSE I can help you with. Assuming you’re still reading.
You know there’s at least one reader out there somewhere right now going, “Honey? It’s around $42 thousand. Yeah, I found it on this really cool financial site – it got right to the point!”
How Much Should You Have In Savings?
When we talk about savings, we should first distinguish between different types of savings. In this context, I don’t so much mean CDs vs. offshore accounts, although that’s a factor as well. I mean that ideally, a working American adult has three things in mind while determining how much to keep in savings.
Long-Term / Retirement Savings
This is money and investments focused on your golden years. It can be committed to things like your 401(k), IRA, bonds, CDs, stocks, or other non-liquid options. Generally, you’re able to earn better terms – including higher interest rates – on money you promise not to access for a set number of years while it’s earning.
Liquid Savings / Current Needs
You can call this type of savings by many different names. This is the money you tap into in emergencies. It’s the money you save up to pay for a wedding or a vacation. It’s the money you probably have the most difficult conversations about with a significant other, if they’re part of your financial world. You’re usually trying to earn a little something on it, but the higher priority is being able to get to it relatively easily if necessary.
Emergency Fund
This is usually a smaller amount – a few hundred to a few thousand dollars – that you have tucked away for emergencies (hence the name). It might even be located in a home safe or part of a secret stash. What constitutes an emergency, of course, varies from family to family. It can be bail money. Helping your adult child out of a tight spot. Calling in a plumber at 2 a.m. because you never knew so much water could come from THERE! The point is, stuff happens. When it does, it’s usually expensive.
Let’s look at each type of savings and talk numbers, shall we?
Long-Term / Retirement Savings
Figuring out how much to keep in savings for your retirement depends on several factors. But let’s start with the easy stuff, shall we?
The general rule of thumb is that you want to have a retirement income of around 80% of your salary before retirement. Presumably, your expenses will drop a little – you won’t be driving back and forth to work, your home is hopefully paid for by this time, and you won’t be devoting so much of your monthly income towards investing for your retirement. Because, you know...
You’re retired.
Figuring out how to make this happen brings up all sorts of uncomfortable questions. What will your health be like by the time you retire? How long will you live? What are you going to do most of the time? Fun or not, these are things which have to be considered when computing how much to keep in savings or invest towards retirement. If you plan on traveling or doing anything different once you’re free from your 9-to-5 grind, you’ll need to plan for that expense. If you’re in poor health, your retirement years could be more expensive because you require additional care. If you’re in great health, your retirement years could be more expensive because you stay alive so darned long.
So try to die at just the right time, if you don’t mind.
The Four Percent Rule
Many experts suggest following “the 4% rule” to come up with a total number you should shoot for upon retirement. Rather than drag through the math, let’s dive into an example and see what that might look like in practice. We’ll use nice round numbers to keep things simple.
In your last few years before retiring, let’s assume you have an income of $85,000. That means our base goal for retirement income is around $68,000 a year. The 4% rule says you divide that target income by .04. If your target income is $68,000, the amount you want to have saved by the time you retire is $68,000 / .04 = $1,700,000. That’s $1.7 million.
Which, I get it, sounds like a LOT. At the risk of being brutal, however, that’s still pretty much what you’re going to need whether you plan for it or not. Knowing ahead of time doesn’t change the reality; it just gives you a chance to prepare a little.
The 4% rule assumes you have no other income. (If you’re getting Social Security, you can subtract that from your target income. That assumes, of course, that your Social Security will be there and be as much as you hope it will.) It also assumes your investments upon retirement continue to earn at least 5% each year, and that you stick to your targeted income each year. Splurging your second year of retirement on a nice vacation or new car doesn’t just mean you have to dial things back the next few years. It reduces the core amount earning the interest which is largely responsible for making the rest of the equation work.
How Do I Get Started?
If you’re like many Americans, you get to about age 60 and start wondering how to save money fast – like, LOTS of money, REALLY fast! While starting late is still better than never starting, earlier is always better when it comes to retirement. Even small, regular investments over a long enough period of time can add up to far more comfortable golden years.
No matter what your age at the moment, here’s where you start if you haven’t already:
Revisit anything your employer offers and the maximum you can contribute. The time to make sense of all that paperwork is NOW, now when you’re a year away from retirement and can’t change anything.
Set aside 30 – 45 minutes twice a week to educate yourself on IRAs and other investment options. You can certainly hire someone to help you with the process, but unless you have a healthy surplus to work with, this can easily become counterproductive. You don’t have to figure it all out at once. Give yourself a few months to sort through your investment and savings options. Check on current rates and projections. Talk to friends or co-workers about their experiences, good or bad. Explore technology which makes it easier to invest, whether small amounts or large.
Pick something and invest. I’m not a huge fan of high-risk investments, but that’s your call. Ideally you have a mix of high return and low risk, but getting there might take a little time if you’re just getting started. It’s OK to learn as you go, but that doesn’t mean you want to be reckless.
Adjust periodically, but don’t get scrambled or think you have to change something every week. Many investments do best if you leave them alone for long stretches.
Liquid Savings / Current Needs
This one has even fewer hard and fast rules for how much to keep in savings. Here are some things you should be considering, however.
1) Most of us can find ways to spend less each month without sacrificing safety, protein, or key family members. My colleagues have written about it extensively here and it takes very little searching to find plenty of good ideas on other reputable sites as well. The key is to keep applying them – even the little ones – each week, each month, each year. Most waste comes in dollars, not twenties; most savings does as well.
2) There are predictable events you’re going to pay for either way. If you drive, you know you’ll eventually need another car. Chances are good your child will eventually either go off to school, get married, or both. Repairs will be necessary for pretty much everything at some point. Most of us get sick or injured over the course of time. You can save now and pay for things as they come up, or you can spend way more to pay for them with credit cards or personal loans. WAY more – without actually getting anything more than you would if you’d saved up.
3) Once you have an emergency fund (see below), it’s almost always better to focus on paying down debt. Whatever interest or security you gain from having an extra $1,000 in the bank is more than offset by the interest, fees, damage to your credit, and stress of owing $1,000 to someone for something. There are conflicting points of view on this, but in general I’d suggest you’re better off knocking down debt sooner than later.
4) It’s the 21st century. You don’t have to walk two miles in the snow each week to deposit a few copper coins into your savings. Take advantage of the information and the technology available to track your spending, find ways to cut costs, and to start saving without having to think about it every time. Come on – are you really going to miss that 47 cents each time you check out at the grocery store?
Save It?
I can tell some of you still aren’t convinced. Let me put it another way.
Let’s assume that you spend an hour or less this week tracking down and cancelling subscriptions you don’t use and automatic renewals of a few things you can live without. If you break it all down, you save yourself $12 per month for your time. No big deal, right? But wait...
Next month you find another strategy – maybe some more intentional grocery and meal planning. That saves you $13 per month. Still not much, but you’re holding the ground you gained last month, so now you have $25 a month more than you did before.
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The following month, you manage to shave about $7. The month after that, you cut something a bit bigger or your renegotiate some debt, making a difference of $22 per month. The following month you talk to your family about changing how you celebrate a few things or what you do for family vacations. This one saves you big, but if we divide it out, it’s something like $31 per month. The following month your efforts don’t gain as much ground, but you still manage to shave about $3 per month. Not very impressive by itself, but let’s look at where we are after only six months. $12 + $13 + $7 + $22 + $31 + $3 = $88 per month.
Think I’m being too optimistic? I’m not, but OK – let’s shave that by a third. $60 per month. Even if you never made another adjustment, you now have over $700 per year more than you did before, all without selling plasma or taking off your clothes. Let’s say you apply that full $700 to paying down your highest interest credit card – how much more will it save you in interest and late fees? Or, if you prefer, add it to your savings.
The point is, start big or start little, but START.
Your Emergency Fund
So, how much to keep in savings for emergencies...? You’re not going to love the answer.
Both experience and the experts say you should have enough to pay your bills and meet your regular obligations for at least three months if you were to entirely lose your income unexpectedly. Six months is actually better. Let’s take a moment and let that sink in.
Now let’s look at two realities before you close this tab in frustration and get back to movie previews on YouTube or reading the latest celebrity rumors. Stay with me – it’s not all bad.
First, it’s doable. Look at the same sorts of stuff we looked at above with Liquid Savings, but call it Emergency Savings. Keep in mind some of these distinctions are logistical. It doesn’t have to be entirely different money – American dollars in one savings account and Euros at a different institution across the world. These categories are useful constructs for figuring out how much to keep in savings. If the answer is almost always “OMG MORE THAN THAT!”, well... at least we’re thinking in the right direction.
Second, if you can’t quite get your head around six months of living expenses set aside for emergencies, start with three. If even that makes your head hurt, start by computing what it would take to keep the family fed and more or less alive for a month and start there. Honestly, $100 is so much better than 0$ that I hate to even assign hard numbers or percentages, you know?
How Has Covid Impacted Saving?
That depends on who you ask.
CNBC recently reported that only about half of all Americans – 53% – say they now have more money in their emergency savings than what they owe in credit card debt. It’s especially bad for the gen z whose emergency savings declined during the pandemic, CNBC claims.
Now when people and businesses finally started recovering from the economic effects of the pandemic, there is a worldwide economic crisis happening, so the prospects for savings are not looking up. However, if we assume that we have learned something from the COVID era I hope that is to be smart about money and learn to deal with and be prepared for the unexpected events.
Conclusion
All savings starts somewhere. The journey of a thousand miles and all that.
Take a step. Then take another. Keep taking them. Eventually, you get places. I promise. Saving even small amounts is progress. So are shaving expenses. So is every block of time set aside to educate yourself on options or encourage yourself with practical ideas.
Don’t worry about what you might be doing wrong or what you wish you’d been doing differently. Focus on what you can start doing today, and tomorrow, and next week, big or small, and do it. And if, along the way, it seems like we could help, let us know.