We all know that Americans as a whole don’t save a lot of money. The latest savings statistics for 2014 shows that the average American only saves ~4% of their income a year. 4%! In other words, it takes the average American 25 years to save just one year’s worth of living expenses. That is a disaster.
When you’re 60-something years old and only have 1.6 years worth of living expenses to buttress your declining Social Security checks, life isn’t going to be very leisurely. You’ll probably be mad at the government for lying to you and mad at yourself for not saving more when you still had a chance.
The problem with averages is that averages distort reality. For example, the average household has a net worth of approximately $710,000. You and I know that this is impossible based on common sense. But simple math doesn’t lie. Take the total household wealth in the US of $81.8 trillion (according to the Fed) and divide by 115,226,802 US households (according to the Census Bureau) and you get $710,000. (Related: How Much Should My Net Worth Be By Income?)
I’m absolutely positive more than 90% of Financial Samurai readers save more than 4%. We are personal finance enthusiasts after all. Therefore, what’s the reality behind this ~4% national savings figure? The truth is that savings rates vary by income.
AVERAGE SAVINGS RATES BY INCOME
Take a look at this fantastic chart by economists Emmanuel Saez from my alma mater, UC Berkeley, and Gabriel Zucman from the London School of Economics.
The dotted line shows the often quoted 4% figure, which is made up of the bottom 90% of income earners. The top 10% to top 1% of income earners save roughly 12%, which I find surprisingly low. It’s only the top 1% who saves an impressive figure at roughly 38%. (Related: Who Are The Top 1% Income Earners?)
The top 1% of income earners can clearly save more of their income because less of their income is being taken up by necessities such as housing, transportation, food, and education. The 38% savings figure also blows away the feel-good myth by the middle class that rich people tend to blow their money and end up broke in the end like the rest of us. The rich are rich for a reason. And one of the reasons is an impressive savings rate. (Related: How Much Do The Top 1% Make?)
KISS FINANCIAL INDEPENDENCE GOODBYE
I strongly believe everyone should start with a minimum 10% savings rate, and gradually increase their savings rate by 1% a month until it hurts. After staying with the painful savings rate figure for several months, the pain starts to go away because humans are adaptable and we will naturally change our spending habits to adjust to our incomes. If your savings rate doesn’t hurt, you are not saving enough.
The ultimate goal is to shoot for at least a 20% steady state savings rate so that every five years of work equates to one year’s worth of savings. By the time you work for 40 years, you’ll have therefore accumulated at least 8 years of savings, and likely many more years thanks to compound interest and investment growth. If you don’t want to kill yourself at work for 40 years like the typical person, then you must figure out a way to save more. If you can somehow manage to save 50% of your income, then there’s no doubt you’ll achieve financial independence within 20 years.
If you make at least $30,000 a year supporting only yourself, I see no reason why you can’t save at least $3,000 a year in your 401k or in an after-tax savings account. Find a roommate, live at home, cook your meals, abolish alcohol, skip out on the latest Justin Bieber concert if you have to. Make savings a priority if you want to be free.
If you are making less than $30,000 a year supporting only yourself, then consider: 1) finding a more lucrative job, 2) building multiple income streams, 3) developing more financial buffers and expanding your knowledge and skills. Of course everything is easier said than done. But that’s what this site and many other personal finance sites are here for.
Come take my savings poll to see what the average personal finance enthusiast saves a year. To clarify “savings rate,” a 20% gross income savings rate on $100,000 = $20,000 in the bank for simplicity’s sake. The reality is that you are saving more than 20% if you calculate your after tax income since $100,000 gross is really only around $80,000 net of taxes. Hence, a 20% gross savings rate is equivalent to a ~25% after-tax savings rate ($20,000/$80,000). I’ve added an after-tax savings poll to be thorough.
RECOMMENDATIONS FOR BUILDING WEALTH
Maximize Your Savings Online: Put your savings in an online savings account that yields close to 1%, or 100X the average money market account. Online savings banks can offer rates much higher than bricks and mortar banks because they don’t have the same overhead costs. Accessing your money online is easy. But having your money in an online bank also helps take away your temptation to always spend.
Manage Your Finances In One Place: The best way to become financially independent and protect yourself is to get a handle on your finances by signing up with Personal Capital. They are a free online platform which aggregates all your financial accounts in one place so you can see where you can optimize. Before Personal Capital, I had to log into eight different systems to track 25+ difference accounts (brokerage, multiple banks, 401K, etc) to manage my finances. Now, I can just log into Personal Capital to see how my stock accounts are doing and how my net worth is progressing. I can also see how much I’m spending every month. The best tool is their Portfolio Fee Analyzer which runs your investment portfolio through its software to see what you are paying. I found out I was paying $1,700 a year in portfolio fees I had no idea I was paying! There is no better free financial tool online.