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Savings Rates

Savings Rates

January 01, 2020

We all know that Americans as a whole do not save a lot of money. An often cited statistic is that Americans save 4% of their income. However, the latest savings statistics for 2018 shows that amount at only about 2.2% of their income for the year. In other words, it takes the average American 45.5 years to save living expenses of just one year. That does not bode well for their financial future.

When you are 60 years old and only have money to pay for only 1.6 years’ worth of living expenses as a supplement for your modest Social Security checks, life is not likely to be very leisurely or comfortable. Almost certainly you will regret not saving more when you still had a chance.

The problem with averages is that averages do not reflect the range of reality. The truth is that savings rates vary by income. What is the reality?

A study from two professors at UC Berkeley and the London School of Economics about the distribution of wealth in the US provides some interesting insights. A summary is that those with more wealth save much more than is often expected or published. Since 1950 the so-called 1 percent have saved 30 to 40 percent of their income. For the top 10 percent, the savings rate is about 12 percent. For the lower 90 percent, the rate is about 4 percent.

The top 1 percent clearly can save more of their income because less of their income is being taken up by necessities such as housing, transportation, food, and education. The high savings figure also contradicts the feel-good myth that rich people tend to blow their money and end up broke in the end. The rich are rich for a reason. One of the primary reasons is an impressive savings rate.

The savings rate of 12 percent for the top 10 percent of earners is actually surprisingly low. My opinion is that everyone should start with a minimum 10 percent savings rate, and gradually increase their savings rate month until it hurts. Perhaps “hurts” is a poor word choice but you are saving for your own benefit. After staying with the painful savings rate figure for several months, the pain declines because humans are adaptable and we will naturally change our spending habits to adjust to our incomes. If your savings rate does not hurt, you are not saving enough.

I would suggest the goal should be at least a 20 percent steady state savings rate so that every five years of work equals one year’s worth of savings. By the time you work for 40 years, you will have accumulated at least 8 years of savings, and likely more thanks to compound interest and investment growth. If you want to work for a shorter period, then your savings rate must be higher.

Consider the concept of financial independence. It does not mean you should retire. It means you have more choices about how you spend your time: different careers, different work patterns, different priorities. But the simple math says that attaining financial independence sooner requires higher savings rates.

Savings can include the tax benefits of retirement plans. Certainly you should capture any employer matching funds. Do not neglect regular taxable accounts because the money is more accessible and fewer limitations.

Savings is actually a matter of priorities. Your lifestyle pattern for dining, roommates, entertainment, and every other expense is a result of deciding what is important to you and setting the priorities and limits on spending. Make savings a priority if you want to be financially independent.