A penny saved is a penny earned—Benjamin Franklin
How much of your money should you be saving for retirement?
Most financial experts agree that you should save 10 to 15 percent of your gross income per year, on top of CPP contributions.
Why?
Because this will allow you to draw from your savings enough income in retirement, along with social security payments (CPP and OAS), to replace most of your income from your working years.
Save less than that and you will have to shift your lifestyle in retirement—or work longer. Save more and you’ll need to shift your lifestyle now (to have more in retirement or retire earlier).
The 10 to 15 percent target allows most people to balance life today with life in retirement.
Which is why it’s recommended.
Standard of Living
Most people save less than 5 percent of their gross income per year, which probably isn’t enough.
How much of your income you should save depends on the standard of living you want in retirement. If you’re happy with a simple life in retirement, you may not need to save much. CPP and OAS may be enough for you. But if you want more, if you’re going to live more than a basic lifestyle, you need to save.
Defining that lifestyle now is important so that you begin working towards it.
For most people, erring on the side of caution and saving more than less makes most sense.
The Middle Road
Financial expert David Chilton put it like this: “When you’re in the savings years, especially in the early ones, there’s no way to know definitively what kind of retirement lifestyle you’ll want. Best to assume you’ll be like most of us and want or need the traditional 60 to 70 percent of your last working-years income.”
Consistently saving 10 to 15 percent of your gross income throughout your career allows you to achieve this 60 to 70 percent of your last working-years income goal.
Want more? Save more. Want less? Save less.
Savings Rate
Building wealth is a matter of your savings rate as opposed to income. What matters is how much you save, not how much you make. You can build wealth on a modest income, but you can’t build wealth without a sufficient savings rate. Make lots of money, as many people do, and save little of your income, and you’ll build little wealth.
If you make $50,000 per year, and save 15 percent of that per year—$7,500—consistently and invest it and earn the average rate of return the stock market has provided over the past 100 years (10 percent per year), you’ll have $1.3 million in 30 years.
One-million-three-hundred-thousand-dollars off a $50,000 income per year.
That’s what a consistent savings rate does for you.
It doesn’t take heroics.
It doesn’t take a massive income.
It takes consistency and discipline.
And not even discipline, because if you automate your savings, it can be done for you without even thinking. You set it and forget it. Skim the 10 to 15 percent off the top. Have it automatically go from your paycheque or bank account into an investment account, to be invested.
Wealth-building, automated.
Latte Factor
In David Bach’s book The Automatic Millionaire he coined the phrase Latte Factor. Latte Factor refers to saving money consistently on some small item, like a latte, and investing that money instead. In the book Bach used the example of a woman who purchased a $5 latte each day, and what that $5 would amount to if invested instead. He said, if you make your latte at home instead, and save the $5, here’s what that money saved consistently over time could grow to if invested, at a 10 percent average annual rate of return:
1 year: $1,885
2 years: $3,967
5 years: $11,616
10 years: $30,727
15 years: $62,171
30 years: $339,073
40 years: $948,611
Compound interest works its magic over time.
Over time the money snowballs.
Over time the $5 saved daily becomes almost $1 million.
The Latte Factor was a metaphor. The money saved doesn’t have to be on a latte, or coffee. The point is we all spend money on small things that add up over time. If you can find one or two small things that you can cut out, that don’t impact your life much, it could add up to millions of dollars—and financial freedom—over time.
Latte Factor Times Two
Find $10 a day of savings, and invest it, and here’s what it adds up to over time at a 10 percent average annual rate of return:
1 year: $3,770
2 years: $7,934
5 years: $23,231
10 years: $61,453
15 years: $124,341
30 years: $678,146
40 years: $1,897,224
Latte Factor Times Four
Find $40 a day of savings, and invest it, and here’s what it adds up to over time at a 10 percent average annual rate of return:
1 year: $7,539
2 years: $15,868
5 years: $46,462
10 years: $122,907
15 years: $248,682
30 years: $1,356,293
40 years: $3,794,448
The point: small things can add up to a fortune.
This isn’t intuitive. But the math doesn’t lie.
Wealth is built one step at a time, like first downs are gained in football one yard at a time. It’s a game of inches. Not heroics.
Andrew Tobias, author of The Only Investment Guide You’ll Ever Need, put it like this: “Short of inheriting or marrying wealth, the surest way to become rich is to save all you can and invest it for long-term growth . . . If you save at least 10 percent of each paycheck and earn a 7 percent annual return, it will take just over 30 years to grow your nest egg to equal 10 years of income. You can then quit work and, with a little kick from Social Security, stay at approximately the same standard of living for the rest of your life. Or keep working (or save even more) to build a yet more comfortable margin of safety.”
The time to start building wealth isn’t tomorrow. It’s today. It’s not when you’re making more money. It’s with the money you’re making today. The power of compound interest works best with time.
Millionaire Next Door
In Thomas J. Stanley and William D. Danko’s book The Millionaire Next Door they profiled how most millionaires in the United States attained their wealth. They said about building wealth: “The goal is to enable you to set aside for investing purposes at least 15 percent of your pretax income each year.” They went on: “Have you ever noticed those people whom you see jogging day after day? They are the ones who seem not to need to jog. But that’s why they are fit. Those who are wealthy work at staying financially fit. But those who are not financially fit do little to change their status.”
Saving consistently, like exercise and brushing your teeth, is the key to good financial health as it is to good physical and dental health.
For nearly all of us, saving—early, often, and regularly—is the key to wealth accumulation. It is as simple as that—John Bogle
Outcomes are the results of habits. Good outcomes come from good habits; bad from bad.
Developing good financial habits early can pay huge dividends.
Bottom Line
Wealth springs from savings. It’s your savings rate that’s most important. Not your income.
Focus on saving at least 10 to 15 percent of your gross income per year and you’ll be setting yourself up for a bright financial future.
If you can’t get there immediately, don’t be discouraged. Work your way up.
And if you haven’t saved that much, don’t be discouraged either. You may, after all, need less than you think in retirement. Sometimes the best things in life are free.