Don’t Save 10% of Your Income, Save 50% of Your Raise
I am often asked by those starting out in their careers, “How much should I save?” It is a great question of course, and one that we should all ask if we want to retire at some point. The quick answer is that you should save at least 10% of your income, but there are many problems with this rule of thumb. The biggest problem is that 10% seems so daunting, especially when first starting out, that many simply don’t get started. On the other side of the spectrum, for those in the higher income brackets, the 10% rule may lead to under saving, and 15% may be more appropriate. Recent research suggests that a different mindset altogether may lead to higher success. Instead of targeting a fixed percentage of your income of say 10% or 15%, set out to save 50% of every raise. This strategy will make it easier to get started, result in a higher long-term savings rate, and will make sure that as your income rises you are saving enough for retirement.
The reality for most Americans is that pay rises over our lifetimes, but it can be difficult to save when first getting started. Instead of getting discouraged, start with a modest savings rate (at least the matching amount), and then slowly increase the amount with every raise. Richard Thaler, University of Chicago professor who popularized this approach, calls it ‘save more tomorrow’. He found that 401k plans that allowed participants to automatically increase their 401k contributions with every raise experienced a dramatic increase in savings rate.
Consider the result of 10 years of saving half of a 4% annual raise: a 20% savings rate. Meanwhile, the budget wasn’t cut, the monthly family income never went down, and retirement savings reach a rate that many see as unobtainable. If you are just getting started, consider making it your goal to save half of your raise each year. It is a terrific way to make retirement savings a reality.