How much do you need to save for retirement? The financial industry consensus is around 10-15% of your revenue. Personally, I think this savings rate is too low. This standard advice is a disservice to the young. A recent grad starting a full-time job will look at this recommendation and try to save 15%. Once it becomes a habit, it can be very difficult to increase your savings rate unless you put in a lot of effort. Granted, saving 15% will probably be enough to fund a comfortable retirement, but is that all you want? Do you really want to work for 40 years and then retire when you turn 65? Saving more will give you many more options. It is unfortunate that most young people do not know the rewards of saving more.
When I started my first degree in engineering in 1996, my dad encouraged me to enroll in a 401K plan. At 22, I didn’t care about retirement and wanted to put any extra money in a savings account. This is a terrible way to save because the money is too easy to access and the interest is low. Luckily my dad kept pestering me to save for retirement and I did. I started out slow, but scaled my contribution to the max in just a few years. Consistently maxing out my 401k has been the best financial decision I’ve ever made. That account is the majority of our net worth and I owe it to my dad. Unfortunately, I didn’t keep careful track of my finances in those early years, so I’m not exactly sure what my savings rate was. It was probably around 25% of my income for most of my 20s.
Regardless, I think 25% is a much better target to aim for. When you’re just starting out, you have a pretty simple lifestyle. You are used to living like a poor student and you don’t need a lot of money to be happy. My lifestyle improved immensely even while saving 25%. It didn’t take a lot of money to beat the lifestyle of starving college students. That is the first reason to save more than 15%.
1. Control lifestyle inflation
Lifestyle inflation gets many people into financial trouble. Saving a higher percentage of your income up front will help you control lifestyle inflation. The more you save, the less money you will spend. That’s why the 401k is a great way to save. The contribution is automatically deducted from their paychecks, and the money is not very affordable. It is much more difficult to obtain that money than from a savings account. When money is easily accessible, you will probably use it.
Of course, some lifestyle inflation is inevitable. We cannot live as hungry students forever. Well, some of us can, but most of us want to live more comfortably as we earn more. I feel that saving 25% or more is a good compromise. If you have a good income, then saving 25% shouldn’t be a big deal. In reality, our savings rate continued to grow as we increased our income. When I realized I wanted to retire early, I was able to kick it into high gear and saved about 75% of our income during my last 2 years of working full time. I was saving all my W2 income and we were living off our other income during this early retirement test. This acclimated us to our current lifestyle and my early retirement has been relatively smooth.
2. Get rich
You will never be rich if you save only 15% of your income. You’ll have enough to fund your retirement, but probably not much more. Of course, the definition of wealth is different for everyone. For me, it means living a comfortable lifestyle, traveling a lot, and having a little to spare to pass on to my son. Also, I think a net worth of $3 million is rich enough.
Can you become a millionaire by saving 15%? Theoretically, it is possible. Dave Ramsey said that he only needs to save $35 a week to become a millionaire in 40 years. Of course, in 40 years, a million dollars won’t be worth much.
Saving a larger percentage of your income is the ticket to wealth for the regular worker. If you can save 25% of your income at first and then increase it to 50%, you will be a millionaire in much less than 40 years. I estimate 15 to 20 years.
The secret to save 50%.
3. More options
Saving more will give you more options when you are older. You may love your job now, but it may not stay that way forever. Saving a higher percentage of your income will allow you to achieve financial independence sooner and you will have many more options then. You can continue to work at the same job, but be more demanding with your assignments. You could change your career to something better. You might even retire early and become a stay-at-home parent/blogger like me. The possibilities are endless when you are financially secure.
If I had known about financial independence when I was 22, I would have increased my savings rate sooner. Those first few years make a world of difference because of compound interest. Working for a corporation was fun for a few years, but life is so much better now after 10 years of early retirement. Early retirement really agrees with me.
Save more than 15%
Finally, saving more does not necessarily mean living very cheap. A better option would be to increase your income and keep your lifestyle the same. We are still saving over $50,000 per year even after I retired. That’s about 50% of all our income. We now have many sources of income and our investments are paying off.
My recommendation would be to start saving at 25% and try to increase it to 50%. This shouldn’t be too difficult if you just graduated from college and are starting a new job. Your lifestyle will still be much better than when you were a student. It’s much harder to cut back if you’re already used to living a more enjoyable lifestyle.
Can you think of other reasons to save more than 15%?
*Passive income is the key to early retirement. These days, I am investing in commercial properties with CrowdStreet. They have many projects in the United States. Go check them out!
Passive income is the key to early retirement. This year, Joe is investing in commercial real estate with CrowdStreet. They have a lot of projects in the US so check them out!
Joe also highly recommends Personal Capital for DIY investors. They have many useful tools that will help you achieve financial independence.