How much should I save is a question that often pops up. It’s easy to answer. Imagine this: You’re carefree. Without a money worry in the world. You’re smiling and the sun is smiling right there with you. Next week you’ll be upgrading your iPhone. Oh, yea, and your 401k is maxed out. How did this happen?
How Much Should I Save? + Savings Calculator
- How Much Should I Save? + Savings Calculator
- Why setting goals might just save your life
- You should focus on these two things when saving for your dream
- Here’s how you becoming a master financial goal setter
- The easy way to afford anything in the world
- Why not all financial goals are created equal
- Examples of how to use the savings calculator to answer how much should I save?
- The power of “saving on savings” through investing
- The takeaway from using the savings calculator
- BIG FAT WARNING!
I’ll tell you how this is going to happen to you too. I’ll tell you how to go from fearing your expenses to conquering them. The savings calculator will help you plan for your goals and adjust. After reading this article you never have to ask how much should I save?
And you get a savings calculator in the end!
Why setting goals might just save your life
You need goals in your life. Not just financial goals. Without goals, you’re adrift on the sea without purpose, without a destination. How you ever heard of a depressed fanatic or zealot? We get disillusioned when faced with a life without purpose. What you aim at becomes possible.
Goals give you purpose. Goals let you dream. You need goals.
Let’s talk about setting financial goals in the context of answering how much should I save. This is the easy bit of setting goals. It even gets easier with our savings calculator
There are two types of financial goals:
- Short-term goals are goals within 1-5 years.
- Long-term goals are goals beyond 5 years.
Why the distinction?
Because when you plan for financial goals you need a portfolio that can help you achieve the financial goal. A portfolio with a 10-year horizon can bear more risk than a portfolio built for a 3-year goal.
Typically, the longer the time horizon of the goal the more stocks and fewer bonds get added to the portfolio. This is because stocks outperform bonds in most cases. Stocks are also riskier. They have bigger swings in price.
How much should I save is therefore dependent on your timeframe.
You should focus on these two things when saving for your dream
There are 3 inputs to a good savings plan:
- Your actual dollars that your save
- Your yearly investment return on those dollars
You can control 1 and 3, but not 2.
You know how much you can save for your goal. That new car costs $4500. You know how much time is left until you reach your goal (right?). You’re looking at replacing the car in 3 years. But you (often) don’t know the return on your investments. If we did know to invest would not be risky and it would not offer a strong return.
Time is the absolute most important of the 3. If we have enough time we could save up to buy anything – really!
Risk and return go hand in hand. You cannot have a safe investment yielding 10% a year. It is not possible.
It is for this reason that you need to categorize your goals into short-term and long-term goals. You need to be able to adjust the risk level of your savings to match the goal.
Here’s how you becoming a master financial goal setter
Make time your most important ally. Use a savings calculator.
How much should I save is joined at the hip with the question of how much time do I have?
The more time you have the less you need to save each month because:
- You can have compounding interest work in your favor. You receive interest upon interest upon interest for a longer time
- The goal is spread out over a longer timeframe making your periodic savings more manageable.
The faster you can identify your financial goals the better!
The easy way to afford anything in the world
The savings calculator built in Google sheets will help you in figuring out how much you should save for your next goal.
There are two tabs on the savings calculator. The first tab lets you answer the question how much should I save for a goal.
The second tab on the savings calculator is for the advanced and lets you define multiple goals at different return levels. I have a forthcoming post on how to completely geek out on savings and make everyone, even Dave Ramsey look like a newbie.
So how much should I save? What about the return, what should I expect?
- If your savings goal is short-term you primary savings should consist of cash or CDs or short-term bonds. If your savings goal is closer to 5 years than 1 year you can increase your exposure to longer-term bonds such as Vanguard Total Bond Market ETF (Ticker symbol: BND)
- If your savings goal is long term you should take a look at our portfolios. They offer a wide range of risk vs. return.
Remember: The best portfolio is one you stick with!
Why not all financial goals are created equal
As you begin setting financial goals you realize that some goals are way more important than others. In popular speak, there are “need to have” goals and “nice to have” goals.
Need to have goals are those goals that will seriously degrade your life or bring major imbalances into your life if they are not met. If these goals are short-term I would minimize the investment risk as much as possible. That means keeping to short- and medium-term bonds without adding any stocks to that particular savings portfolio. I would consider a 50th-anniversary celebration in the “need to have” category and would not take much investment risk. My savings would go into CDs and a short-term bond fund.
Nice to have goals are just that, nice to have, e.g. a new iPhone in 5 years. Personally, I don’t mind introducing a small amount of investment risk when saving for these types of goals. My money would go into a bond fund such as Vanguards BND ETF. Note this is still very low risk in the investment world!
Examples of how to use the savings calculator to answer how much should I save?
Let’s take 2 examples to demonstrate the power of the savings calculator:
Example 1: Short-term goal using the savings calculator
I’m going to need a new bike in 4 years. I like bikes so I’m planning on buying one that will last the next 10 years. The one I want costs $1500.
It’s a short-term goal with a “nice to have” sticker on it. If I have to wait another 6 months it wouldn’t kill me. I’m going to put my saving in an aggregate bond fund such as Vanguard BND ETF.
How much should I save if I want my new bike? Here’s what it looks like in the savings calculator:
Example 2: Long-term goal to demonstrate the power of the savings calculator:
I want to get a house within the next 8 years. The down payment is $40,000. I’m willing to take a good amount of risk since it is in 8 years’ time. I’ll build a failsafe into my savings plan by over saving. I’ll save $5000 more than I need.
Looking at the portfolios on portfolioeinstein.com I’m going with a 60/40 portfolio. That is a portfolio consisting of 60% stocks and 40% bonds. The returns for that portfolio the last 10 years has been 7.26% percent.
How much should I save if I want my down payment ready in 8 years? Here’s what it looks like in the savings calculator:
You can find the savings calculator here. Be sure to go to file > make a copy, in order to be able to make changes.
The power of “saving on savings” through investing
In the first example, I need to save $364 a year to get to my goal of $1500. That’s $1 a day according to the savings calculator – I think I can make that!
But look what happened! Because I put my saving in a bond fund that is expected to yield 2% I’m effectively getting a 2% discount every year on my savings! Wow!
Here’s the math:
Savings goal: $1500
Actual saved: $364 x 4 = 1456
Total saved on savings = 1500 – 1456 = $44
That may not seem like a lot but if you have many goals it adds up and it is basically free money.
But wait! Look how much I saved on savings on my down payment:
Savings goal: $45000 (remember I over saved to compensate for the higher portfolio risk)
Actual saved: $4345 x 8 = $34760
Total saved on savings: $45000 – $34760 = $10240 (!)
Now, this is a meaningful amount of money. And all I have to do is save $11 daily according to the savings calculator.
The takeaway from using the savings calculator
- If your goal timeframe is short you need to save a lot more “yourself” and you need to take a lot less risk. You don’t get a lot of free money.
- If your goal timeframe is long, the compounding effect will help you save a lot more because you can take more risk over a longer timeframe.
To put it another way: You get hit twice as hard if you fail to plan ahead and get rewarded twice as much if you can look ahead.
Short term planning – expensive
Long-term planning – cheap
How much should I save = how good am I to plan!
BIG FAT WARNING!
The above examples do not take fees nor commissions into account when investing your money. The returns mentioned are also hypothetical as those were the returns from the past and NOT the returns you will experience in the future. They are the best guess we have, however! Sometimes the commissions will eat into your “saving on savings”.
Also, take taxes into consideration. You might have to pay capital gains tax on your returns depending on your holding period.
You’ve just been introduced to the saving on savings principle. To answer the question how much should I save requires that you have a goal and some number:
- The price of the goal
- The timeframe of the goal
- The expected return of the portfolio that will support your goal
The number can be plotted into the savings calculator and will give you an answer.
Now that you have begun your savings journey, what are you going to save up for?
Which portfolio is suitable for your savings target?
Sign up for our newsletter to get more great tools and advice on how to combine investment portfolios with personal finance.
If you’re unsure how to get started in investing be sure to read our article How to invest money – 5 simple steps that work for anyone.