How Much Savings Is Too Much?
Prodigious savers of the world, unite! From the post, “How To Retire Early And Never Have To Work Again“, I mention I’ve saved roughly 15-18 years worth of living expenses after saving 55-75% of my after tax income every year for the past 13 years. If you do the math and follow the chart in the post, you’ll see how you too can save 15-18 years of expenses in 13 years time.
Conventional wisdom says to save six months to one year’s worth of living expense in case something happens to your main source of income, whether voluntarily or involuntarily. However, I don’t know where this 6-12 months barometer came from, because frankly, I think that’s not very much.
Goodness forbid you lose your job, don’t get a severance, and have a major medical emergency. Even with health insurance, a 20% copay of something expensive is still a lot of money!
THE IDEAL AMOUNT OF SAVINGS
Instead of saving 6-12 months worth of living expenses, I sugest you shoot for 36 months worth of total living expenses so you don’t have to worry about a thing if something bad happens. I’m not saying you should have 36 months of living expenses sitting in your checking or money market account at 0.01%-0.2%. Instead, I’m talking about having 36 months worth of living expenses spread out between savings, CDs, and trading accounts which are easily accessible. Six months worth of liquid savings in your money market should suffice if you have 30 months worth of savings in other easy to access accounts.
Three years is a long enough time to weather the most brutal of downturns. Remember when the markets began to crumble in 2000 from the dotcom bubble? By the end of 2003 and early 2004, the economy had recovered quite nicely. Remember when Armageddon hit in the 4th quarter of 2008? It’s now a normal market with unemployment down from the peak and the Dow back to 12,600 as of 6/28/12. Amazing how far we’ve come in three short years!
The worst thing you can do is sell assets when you really need to sell. Imagine all the people who sold when the S&P 500 was below 800. How about all the people who had to sell their properties in the past 4 years? The majority of people who sold stocks and real estate because they needed the money are kicking themselves now!
Never sell anything when you have to sell! Having a three year savings cushion will ensure that you financially don’t self destruct and run with the herd like a rabid hyena.
HOW MUCH SAVINGS IS TOO MUCH?
Given I recommend three years or more of livings expenses saved up in liquid to semi-liquid accounts, how much savings is too much? My initial belief is that no amount of savings is too much so long as you are happy. Even if you are super frugal with your money, so long as you are happy, and the people around you are happy, then all is good.
Despite my philosophical answer, we should all understand there is a backstop. Our lives are finite, and the large majority of us will not live past 100. Working in reverse, we can calculate that most of us need about 18 years of education to begin working a real job. The first 3 years is hard to save given the lower level of income and potential debt repayment. At a 50% after tax savings rate, it takes one year of work for one year of savings. By the time we are in our mid 40′s, if we are saving 50% of our after tax income we can cruise on into retirement if we want.
Based on where I am with my savings, and the quick back of the envelope calculation above, I say that saving anything more than 10-15 years worth of living expenses once you’re over 40 years old is too much and totally unnecessary. I know people who have fantastic pensions and are still saving despite having 10+ years worth of living expenses covered!
CONCLUSION TO SAVING
Ever since I first graduated college, I’ve had a target to save 20-25 years worth of living expenses by age 40 so that I could have the optionality of retiring and doing whatever I want when the time comes. I realize that my current 15-18 years worth of savings is an overkill, because there are so many things one can do to make money e.g. teach, write, start a company, etc.
Having an aggressive savings goal pushed me to work hard. I knew that the only way I could obtain my savings goal was to not settle for any old job either. The job had to be fulfilling, otherwise I would likely quit after a couple of years due to disatisfaction. Having a savings goal also helped calibrate what I find to be a good lifestyle with the right amount of expenses. A large cushion also gives me the freedom to explore the unknown without fear.
If you can treat savings like a game and challenge yourself to save more, I’m sure you’ll have a much easier time. Set milestone targets in 3 month increments and celebrate each step of the way!
Recommendation For Optimizing Savings:
I suggest opening up a high yielding online savings account with EverBank. They currently offer a 1.11% interest rate on savings which is 10X greater than the national money market average of 0.1%. Withdrawing and depositing money is easy online as you wait to invest your cash. Don’t let the banks get away with paying you so little!
Updated as of 12/01/2013.