In 2016 and 2017, something truly alarming happened. And almost nobody noticed. According to the Bureau of Economic Analysis, we Americans halved our average savings rate, from an already low 6% to an extremely low 3% of take-home pay (source).
Why does this matter? And what should your savings rate be? Let’s discuss!
Why Savings Rate Matters
Your savings rate is the best predictor of your future financial success. Why? Because your savings rate determines how long it will take you to reach financial independence, the point at which your investment income alone can pay for your expenses.
The table to the left shows the # of years to financial independence based on your savings rate. In case you're curious about the fun math behind the table, we've added detailed notes below the article.
The big takeaway here? Increasing your savings rate has a dramatic impact on how long you'll need to work for money, as opposed to working by choice. If you save 10% of your take-home pay, you’ll need to work for 51 years. Increase that savings rate to 50% and you’re only looking at 17 years!
So how long would the typical American with a savings rate of 3% need to achieve financial independence? 76 years!! That means if the typical American starts working at 22 she’d need to work until she’s 98 to achieve financial independence!
I don’t know about you, but I don’t plan on working full time that long.
How much should you save?
If you want to rapidly achieve financial independence, I recommend a long-term goal of saving over 50% of your take home pay. Half your income would go to others (spending). Half your income would go to you (savings).
This savings rate might seem impossible from where you’re starting today. Like any big challenge, take it one step at a time. If you’re currently saving 15%, try to increase to 20% in the next few months by increasing your income or reducing expenses. Then keep growing your savings rate from there.
If you’re not currently saving, or saving very little, I recommend first targeting a 10% savings rate. I see 10% as a bare minimum you need to achieve financial independence. Commit to putting away 10% of your income (or using 10% to pay off debt), then increase from there.
One last thing. As you start increasing your savings rate, people with typical American savings rates may say you’re crazy or that “money comes, money goes, you need to spend it while you’ve got it.” Remember how long those typical Americans will take to achieve financial independence and your the best path forward will be clear.
Fun math notes about the table: I assume a 5% return on your assets after inflation, which is reasonable and perhaps conservative based on the market’s historical average. I also assume a 4% asset withdrawal rate in retirement. Finally, I assume you’re starting at a net worth of $0, where your assets equal your debt. For more information, check out this outstanding 2012 article by Mr. Money Mustache, one of my favorite personal finance writers, on the subject.