The percentage of your income that you stash away has a direct impact on the growth of your net worth. In this article I will discuss why you should be saving as much as possible, as soon as possible, in order to set yourself up for financial independence much sooner.
What is Saving Rate
Your saving rate is calculated as the percentage of income you put towards saving and investment accounts each period.
Why to increase when possible (or the magic of compounding)
The percentage you put away is important because when it comes to your saving rate, less is not more. Thanks to compound interest, it’s important to save as much as you can, as early as you can. Even if you don’t think you can save much now, start somewhere. Maybe that start means putting 1% of your paycheck into a savings or investment account this month. Next month, try 2% and see how it goes. Then 3%. 4%. Continue until you hit a natural friction point between your saving rate and how much cash you need on hand for the month.
As you get promoted or raises come in, increase your saving rate as well. Find the balance between a comfortable lifestyle now, and being able to maintain a comfortable lifestyle in retirement. As I discuss in my article on compounding:
Essentially, you invest some money and watch it grow as the interest compounds over time. Speaking plainly, imagine you have $1 and you invest it. Given enough time, with no further contributions, $1 becomes $2, and then with more time, $4, then $8, $16, $32, $64, $128, $256, $512. Just from that initial contribution of $1! It’s an amazing concept and a key contributor to building wealth.
I highly recommend reading that article in conjunction with this one if you haven’t already.
Where to save / invest
The right number
Finding the right rate is something you are going to have to play with. At a bare minimum, I recommend 10%, but you should strive for more. The early retirees that we hear about in the news had a saving rate >50%. I’m not saying you need to be this extreme but the more you can put away now, the more exponential growth you can expect.
It’s a basic calculation to determine your saving rate but if you want to keep track of it over time, or play around with various increase scenarios, then check out my Personal Finance Companion.
By increasing your saving rate and letting it compound, you grow your wealth while also living on less. It’s a basic concept but one with a lot of potential upside.