When someone asks how much money they should save each month, I throw them a curveball reply:
"What are your goals?"
That's a serious question. Your ideal savings rate depends on your specific, long-term reasons for saving.
There are three timelines you should consider:
Less than 1 year
Your short-term savings can get used to vacation in Aruba, buy holiday gifts or pay your taxes.
Less than 1 decade
You might use this money to replace your dishwasher, fix your car's timing belt, cover a major insurance deductible, stay afloat when you're between jobs and make a down payment on a home.
Retirement is the ultimate long-term savings goal.
Let's go back to the original question: How much should you save? Let's break this down by goal:
You should consider saving 10 - 15% of your income for retirement. Sound daunting? Don't worry: your employer match, if you have one, counts. If you save 5% of your income and your boss matches another 5%, you've accomplished a 10% savings rate.
You should establish an "emergency fund" that can cover 3-9 months of your living expenses.
How can you save such a large sum? First, calculate your monthly cost-of-living. Assume that if you lose your job, you'll sacrifice luxuries such as pedicures or your premium cable TV package. How much do you need to survive?
Divide that number in half. Can you save this monthly? If so, you'll build a six-month emergency fund within the next year.
3. Everything else
Make a list of major expenses within the next decade, ranging from replacing your gutters to throwing your wedding. (If it's easier, list broad categories like "home repairs," "holidays" and "wedding.")
Write your ideal savings target and deadline. Divide by the number of months remaining to see how much you should save. Want to pay cash for a $10,000 car in five years? You'll need $167 per month.
When you run through this exercise, you'll probably discover that you can't save enough for every goal on your list. You have four options:
- Re-imagine your goals
- Lengthen your timeline
- Cut your current spending
- Earn more
Most people opt for a combination of those four choices. You might decide you'd be happy buying a $7,000 car, which will require only $116 per month. You cut your $50 cable bill and pick up a babysitting gig one night per month, and voila — now you're on-track to pay cash for your next car.
Did you want a simpler answer? No problem. Here's a final rule of thumb: at least 20% of your income should go towards savings. More is fine; less is not advised.
Meanwhile, another 50% (maximum) should go towards necessities, while 30% goes towards discretionary items. This is called the 50/30/20 rule of thumb, and it’s popular quick-and-easy advice.
If you want to optimize your savings, run through the exercise described above. You’ll thank yourself when you’re boarding that flight to Aruba.
Paula Pant is an award-winning personal finance journalist who has been featured on MSN Money, Bankrate, Marketplace Money, AARP Bulletin, and more. Her website, Afford Anything, draws 30,000 visitors each month.
Teachers Insurance and Annuity Association of America (TIAA) has sponsored this post for information purposes only. Paula Pant is unaffiliated with TIAA, College Retirement Equities Fund, and their affiliates and subsidiaries (collectively TIAA-CREF), and TIAA makes no representations regarding the accuracy or completeness of any information on this post or otherwise made available by her. Ms. Pant’s statements are solely her own and are not endorsed or recommended by TIAA.
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