In the following post I hope to convince you why it’s a great idea to drastically improve your savings rate by showing you the massive benefits that will come from it. The numbers don’t lie and they are very convincing!
Penny Wise and Pound Foolish
Somewhere along the way you’ve probably heard the phrase penny wise and pound foolish. This, of course, deals with the monetary system used in the UK whereby a pound is the equivalent of a dollar and a penny is still a penny.
It also refers to someone who is good at pinching pennies, but makes somewhat regrettable larger purchases. Someone who buys a top-of-the-line coffee maker (google it and you will see these run from $3,200 to over $25,000!) and then uses Folgers coffee to “save money” comes to mind.
Obviously, if saving is your ultimate goal, penny wise and pound wise would be the most desirable approach. I think I started out that way in life.
Then, my wife and I bought a fixer-upper house and I couldn’t spend money fast enough. $10,000 for this, $1,500 for that. Sure, why not? That’s what I had saved for right? At this point, I was an embodiment of the original saying of penny wise and pound foolish.
But then I got to thinking (Uh-oh). “If I’m spending these huge sums on my house, why am I drinking such crappy coffee and eating like I’m still in college?” Now, no expense could be spared for anything. I wanted the best of everything. I had become Penny foolish and pound foolish.
Presently, I am seeking a happy medium. I grew to appreciate some of the smaller delicacies, but also realized I didn’t need it all. Especially when I saw my financials tanking!
As I write this, I am happily nestled into a penny foolish and pound wise state of living. I spend a little more on some things I enjoy (like olive oil and coffee) but I don’t get sucked into the massive expenditures that will hurt my long term financial goals.
This is worth it to me. It allows me to enjoy the now and still feel good about planning and setting myself up for the future.
What’s a ‘Good’ Savings Rate?
In my general outline of how I plan to retire early on a teacher’s salary, I highlighted “Improve Savings Rate” as one of the key steps.
We often fall into the trap of thinking we need to earn more in order to be able to save. A lot of times, however, the money is right there to be had. We just need to cut a few things out. That is what I am trying to do.
If time is what I value most, then something has to give. In my mind, it is absolutely worth it.
But what is a good savings rate? First off, let’s talk about “saving’s rate” as “the amount of money that I save per given paycheck”. If I bring home $1,000 and I save (or don’t spend) $100 of it, then my savings rate is 10%.
A 10% savings rate is what the consensus opinion is for a “good savings rate”. You often read it on a lot of traditional retirement sites.
I hope to flip that on its ear. I want to go significantly higher. First though, let me show you an extreme example. Then you won’t find mine to be so outlandish!
I hope it also opens you up to some of my ideas for simple steps to big savings (next article) so you can improve your savings rate as well.
An Extreme Savings Rate
If 10% is the savings rate you generally hear to be good, what might constitute an extreme savings rate?
This article is about Scott Rieckens, and is a good, quick read. Basically, he and his family were living the lavish lifestyle on the beach, making good money and saving next to nothing. Then, he heard an interview from Mr. Money Mustache on the radio about the FIRE (Financial Independence Retire Early) movement and everything changed.
Almost overnight, he and his wife’s savings rate went from about 7% to around 70%! He actually made a documentary about it called Playing with FIRE which I plan to watch and review.
My sense, reading up on it, is that it was very difficult for Scott and his family and I believe they ultimately scaled back on 70% as their number(they might have settled on 50%). I have heard other people take their savings rate as high as 80%!
For me, that’s impractical. I suspect it is for a lot of you as well (If not, go for it!). What then, is a good savings rate to aim for to still dramatically impact your future goals without throwing away the present.
A Reasonable Savings Rate
A Reasonable Savings Rate? Well, so much for the headline of this post, huh? Sorry, but Improve Your Savings Rate Reasonably has no hope of clicks. I’m scraping and clawing here so cut me some slack!
Now that we’ve heard examples of people that get their savings rate as high as 70-80%, I’m hoping my goal doesn’t sound so bad.
How does 40% sound? That’s my savings rate goal. I figure I can pull it off with some sacrifices but without too many mental gymnastics. No cutting coupons or driving long distances to save 9 cents per gallon on gas. Our job is too demanding as it is, and I don’t have the bandwidth to add another thing to it.
I’ll make some simple cuts. I’ll also show some of that discipline that I preach to my students. And at the end of it all, I hope to be at or around a 40% savings rate. This post, Simple Steps to Big Savings, highlights some of the “non-drastic” steps I am taking. Check it out. They’ve already made a huge difference!
Also, it needs to be said, that we all have different financial situations. We all have varying mortgages/rents, car payments, student loans and other expenses. These can all be extremely burdensome. Maybe 40% is unrealistic for you. But is there a way you can find ways to improve your savings rate? If so, I think it’s worth it and when you see the numbers, I think you’ll agree.
Also, let me say this. If you are daunted, like so many of us, by those school loans, mortgage payments, car payments etc. do not fret. There are answers/solutions to be had! When I was doing my deep dives, I was astounded by the creative solutions people had for all those problems and more (like putting your kid(s) through college).
If you want, go ahead and contact me. Tell me what you want me to look into, and I’ll research it for you and write up a post about it (while obviously maintaining your anonymity). These debts can seriously weigh us down. It’s very real! Part of what I want to do is help alleviate that burden so you can better focus on the important work you are doing.
For now, let’s look at an example of what happens if you improve your savings rate. If you can do it, the math will smile down on you!
The Simple Math of it All
In order to do this, I’m going to have to make some assumptions. We all have drastically different pay scales. And as we age that salary goes up. So, for the sake of this example I’m going to assume a monthly salary of $2,500 after taxes. That seems reasonable to me.
So, if my savings rate is 40% of that, then I save $1,000 per month. Nice and neat!
And if you haven’t read my post on the magic of compounding interest, now is a good time to do that. It shows how, over time, money that is invested can balloon to life changing amounts.
So, as always we will assume an annual rate of return on investments of 8% because that is what the market has returned, on average, since it’s conception.
Now comes the fun part! I’m just going to type “compounding interest calculator” into google. and start punching in numbers. I like this one here from Nerdwallet.
I put in the “initial deposit” of $1,000 (Usually you have to start with something to begin an account. Also, it wouldn’t let me put in 0 as an amount!)
For “Contributions” I type in $1,000 and click “monthly”.
My “Rate of Return” is 8.0% and I click “annually” for “compound frequency”. This will give me the lowest results.
For “Time Span” I will start with 10 years. And remember, even if I don’t invest it, saving $1,000 per month is equal to $120,000 after 10 years. That’s nothing to sneeze at!
Instead, if do invest that money and get an 8% return, my total after 10 years equals $176,158.
I can hear you now. “Good. Sure. But it doesn’t exactly blow my mind.”
Fair enough! But I will say that you have an extra $56,158 for doing next to nothing. Still, I get your point.
But remember, time is another crucial ingredient. Let’s see what happens to that money given more time. We’ll go in increments of 5 years over a 30 year career.
Savings Rate Over Time
Here is a table of the dramatic (or dare I say drastic?) improvement an increased savings rate can have on your financial goals.
Watch what happens over time. One column will show your savings if you didn’t invest (still good). The other shows what happens if you do invest and get that 8% rate of return.
| Years | Savings (w/out investing) | Savings (Investing at 8% return ) |
|---|---|---|
| 5 | $60,000 | $71,978 |
| 10 | $120,000 | $176,158 |
| 15 | $180,000 | $329,233 |
| 20 | $240,000 | $554,150 |
| 25 | $300,000 | $884,628 |
| 30 | $360,000 | $1,370,207 |
For me, this table got my attention at the 15-year mark. $329K vs $180K. That’s a difference of about $150K. Now we’re cooking with gas! That’s like getting a $10,000 dollar per year raise for doing the exact same job.
After 20 years, it’s game over. At $550,000 with some sort of side income and a halfway decent pension, I’m riding off into the sunset. That’s 10 years of time at your disposal. Imagine what you can do with 10 extra years?
These are life-altering changes and it came from doing very limited extra work.
Now let’s look what happens if you stick with the conventional wisdom of a 10% savings rate.
10% Versus 40%
Just for fun let’s see how the conventional 10% savings rate stacks up against the 40% savings rate I plan to use for myself.
In this case I will invest both amounts at 8% and use the same $2,500 monthly salary after taxes.
10% of $2,500 is $250. That means after 1 year (12 months) I would save $3,000.
So let’s look at the difference over time if they are both invested at the same rate of return (8%)
| Years | Total w/10% Savings Rate | Total w/40% Savings Rate |
|---|---|---|
| 5 | $19,097 | $71,978 |
| 10 | $45,659 | $176,158 |
| 15 | $84,688 | $329,233 |
| 20 | $142,034 | $554,150 |
| 25 | $226,294 | $884,628 |
| 30 | $350,099 | $1,370,207 |
Summary
I really think those numbers speak for themselves. I find the math on that to be very compelling. That is the reason why I am convinced that I need to improve my savings rate.
Rather than picking up extra work and exhausting yourself even more, I think it’s a lot easier to make some cuts to your spending. Just improve your savings rate, invest wisely, and let the math do the work for you.
And that’s just the beginning. Questions like “What if I increased my savings rate to 50%? Or, “What if I got a summer job and invested all of that money?” come to mind as well along with so many others.
In the end, each person can find a path that works for them. For now, I hope you are convinced that if you improve your savings rate, it can have a drastic (I’m all in on drastic!) impact on your financial outlook.
With a new financial outlook, all sorts of possibilities are at your disposal.
As always, thank you for reading. Please feel free to ask any questions or leave comments below. Also, if you have a specific question on a specific type of debt that is weighing on you, contact me and I’ll happily do that deep dive for you (I’ll get some good content as well!) Thanks everyone and be well!
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