Everybody agrees saving income is vital. It helps protect you in the event of a financial emergency and sets you up for a comfortable retirement. However, figuring out how much of your income should you save can be tricky. It's hard to know what you should put towards savings and debt repayment.
How much should your saving goals be for every month? The answer largely depends on your monthly income, financial goals and lifestyle, but most experts recommend saving at least 20% of your paycheck.
Things to Know About Saving Income
As a child, you might have saved nickels, dimes and quarters in a piggy bank. However, as we get older, many of us lose the good habit of saving.
Why? Maybe life gets in the way. You mean well and want to spend less, but something always comes up. Perhaps you are busy repaying the student loan or love eating out in a fancy restaurant every other day. Or maybe you tend to overspend without meaning to. Whatever the reason, at some point or another, almost everyone has found saving income difficult.
While many things change when we get older, there is one thing that does not — the importance of making savings goals for the future. Thankfully, saving for long-term goals, like a house or retirement, or saving for an emergency fund, does not have to be painful and difficult. You can reach your savings goal without feeling that you are sacrificing too much.
Follow the money-saving tips shared in this post to build your nest egg the stress free way. However, first let us look at why saving income is important.
Why is Saving Income Important?
Saving is vital because it gives you greater financial stability, security, and freedom. Having a substantial nest egg also opens up options that improve quality of life and gives you the courage to face life’s uncertainties with confidence.
Here are five reasons why you should have a savings goal:
The measuring stick for being rich is different for different people. However, most people equate ‘being wealthy’ or ‘rich’ with financial independence, which in essence is the freedom to live the life you want.
Money in your bank account gives you freedom to:
- pursue your dream career
- choose what you want to do, when you want to do it
- retire when you want to
- help your friends and family members.
As much as we hope emergencies do not happen, we all know that is not possible. One or another financial emergency is going to come our way, whether it is a family member falling sick or the car breaking down or some other circumstance where we would be grateful to have an emergency fund. It is best to be prepared rather than let financial emergencies overwhelm us.
Having some emergency savings can help you avoid adding financial stress to your worries and turning a bad situation into something worse.
Down Payment on a House
If you are thinking about buying a home, you will need to have at least 5% down payment saved first. The bank will not extend you a home loan unless you can put down at least 5% of the purchase price. You may wait until you receive a windfall, but a more effective way of realizing your dream of owning a house is having little savings goals every month for the down payment.
Major Life Events
Major life events can significantly impact your personal finances. Whether sudden or planned, they generally involve spending a lot of money. For that reason, it is generally considered a good idea to start saving for them.
Common major life events that affect your finances in a big way include:
- birth of a child
- job changes or termination
- buying a house
Your Child’s Education
The cost of higher education continues to rise at a faster rate than wages, but schooling is still the best way to secure a bright future for your child. By starting to save early, you can reduce the burden of taking a high debt to fund your child’s higher education.
Leverage the Power of Compound Interest
The benefit of making savings goals early is that you can leverage the power of compound interest more effectively. Compound interest makes your money grow at a much faster rate since the interest is calculated on the principal amount plus the accumulated interest over time. In short, compound interest makes your money work for you.
How Much of My Income Should I Save Each Month?
Many experts recommend saving 20% of your monthly income. According to the popular 50/30/20 rule, you should divide your monthly take-home pay into three spending categories: 50% for essentials like food and rent, 30% for wants, and 20% for savings and debt payments.
Saving 20% of your monthly income is sound advice, but if your present situation does not allow you to save that much, do not get frustrated. Saving something is better than saving nothing.
On the other hand, if you are a high earner, you should aim to save more than 20% of your after-tax income each month.
How Do I Save Money?
When it comes to saving income, small changes can make a huge difference.
Here are five straightforward ways to start achieving savings goals right away:
Record all your expenses
You cannot gain control over your spending until you know where your money is going. Start tracking all your expenses — that means every Uber ride, household item, and cup of coffee, as well as recurring monthly bills. You can track expenses any way you like, for instance, using an excel spreadsheet, a free mobile app, or pen and paper, but the important thing is to record them conscientiously.
After accumulating data, start organizing the spending by categories, for example, mortgage, gas, groceries, and entertainment, and total each amount. This will give you a complete picture of how much and where you are spending your money.
Create a budget
Your budget should include a savings category and will reveal how your monthly expenses compare to your income. Having a budget will help you to get a firm handle on your spending and start saving toward your financial goals. You may not be able save 20% of your take-home pay right off the bat, and that is okay. As long as you are moving in the right direction, you will get there.
Cut your expenses
If you are unable to reach your savings goals, find ways to reduce expenses. Separate needs from wants, and within the latter category, identify those on which you can spend less. For example, if you drive to work, gas is a need. But the new iPhone on which you have set your heart is likely to be a want. Deciding not to buy it can increase your savings by roughly $1,400.
Here are some additional tips to help you save more:
Carry a list when you go shopping
More importantly, stick to it. While walking through the aisles of a retail store, it is so easy to grab a box of chocolates here and a few packets of potato chips there, and then top them off with a few goodies at the checkout counter. All of these small impulse purchases can quickly add up and blow your monthly budget time and time again. If you have young children, try leaving them at home when you go shopping. With young children in tow, sticking to a list can be nothing short of mission impossible.
Cancel automatic subscriptions you do not use regularly
Review your automatic subscriptions and memberships and cancel those you do not use frequently. If you buy a new subscription, deselect the auto-renew option.
Wait before you make a big purchase
If you want to buy something you think you need, take a few days to think on it. Will the new purchase mess up your budget or get in the way of your savings goals? Will it lead to reduced savings over the next several months? How will it improve your daily life? Is the benefit worth the price tag?
If after a week, you have forgotten about it, that shows you did not really need it.
Set long-term and short-term saving goals
You must be clear about why you are saving up. Otherwise, saving income will remain one of those things that you thought about doing but did not get around to doing.
Without financial goals, it is no big deal to spend $10 here and $20 there. On the other hand, once you define your goals, your outlook toward money will change. You will start to see how every spending decision affects your greater financial health.
Once you have defined your financial goals, set a timeline for each one of them. Short-term goals usually have a timeline of one to three years while long-term goals have a timeline of four years or more. Next, figure out how much you will need to save every month for each of your goals.
Common short-term goals include emergency fund, down payment on a new car, and vacation. Examples of long-term goals include down payment for a house, your child’s education, a home remodeling project, and retirement.
A high yield savings account is better for short term savings whereas, putting money in a retirement account creates a better financial future.
Avoid credit card debt
No one wants to fall into credit card debt, but it can happen quickly if you are not careful.
Treating your credit card like you would cash is the most effective way to stay out of credit card debt. Before using your credit card for a big purchase — like the PlayStation 5 — ask yourself: “Can I afford to pay it in cash right now?” If the answer is no, resist the temptation.
In addition, always pay your statement balance in full every month. Doing so ensures you will not accrue interest. If you are worried about missing a credit card payment and do not have any cash flow issues, set up auto pay. However, make sure you regularly review the transaction history of each of your credit card accounts to catch any unauthorized transactions quickly.
How Much Should I Save for a New Baby?
Becoming a parent can be both an exciting and overwhelming experience. Before the baby arrives, you should plan your finances because raising a child is expensive in Canada. How much money are you likely to spend on your baby during the first couple of years?
Estimates suggest the average Canadian family will spend about $16,500 on child-related expenses during the first couple of years. Factor in the pregnancy-related costs as well. A normal pregnancy costs roughly $4,500 with insurance. This figure can be anywhere between $30,000 and $50,000 if you do not have coverage.
How much do I need for Retirement?
How much money you need for retirement depends largely on two things: your total net worth and individual circumstances. The conventional wisdom says for a comfortable retirement you will need at least 70% of your current salary.
This guideline presumes that you will spend slightly less money after you retire. You will have fewer or no dependents, no commuting expenses, no monthly mortgage payment and obviously you will no longer have the need to save for retirement.
For instance, if your current annual income is $90,000 a year, you can reasonably expect to need $63,000 each year after you retire.
To find out the total amount you should save for retirement, multiply 70% of your current annual income by 25. The average life expectancy in Canada is 81, so you can reasonably expect to live that long after retirement. In the above-mentioned example, that would mean saving $1,575,000 for retirement.
Of course, you will likely need more if you do not expect your lifestyle to change much after retirement or you have not paid off your mortgage. Some financial experts say it is better to aim for 90% to 100% of annual income.
The 4% Rule
Want to calculate how much you need to retire? The 4% rule is a simple method for calculating how much you will need to save to produce your desired annual income in retirement. A retirement income of $80,000 would require a nest fund of around $2 million ($80,000 / 0.04).
Places to Save Your Money
Forget the couch cushions and the safety deposit box. There are better places to put your money and make the most of every dollar saved.
High Interest Savings Account
High interest savings accounts are a good place to put your money since it offers a much higher interest rate than a regular savings account. How much more depends on what features are being offered. For example, some high interest accounts will give you an above-average interest rate but require a minimum balance. Others may offer a more moderate rate in return for fewer limitations.
If you will not need your savings for a year or more, consider opening a term deposit. There are no startup fees and you earn a fixed rate for a fixed term.
Tax Free Savings Account (TFSA)
A TFSA is a tax-advantaged savings account available to all Canadians over the age of 18 years that earns money tax free. TFSA-holders can hold qualified investments such as cash, mutual funds, bonds, stocks in their savings account and withdraw money any time, without paying any tax. Investing in the stock market always has some risks but, help from a personal finance advisor can mitigate these.
Investing in an Annuity
Annuities allow you receive a steady stream of income over time which can help keep your expenses paid for and help you secure a strong financial future.
Registered Retirement Savings Plan (RRSP)
An RRSP is a retirement savings and investing vehicle that allows you to save money for retirement on a tax-deferred basis. As a result, you can invest more money and it will grow faster. By the time you reach retirement age, you are likely to be in a lower tax bracket, which means the withdrawals will get taxed at a lower rate.
How much of your income should you save? A general guideline is to save at least 20% of your income. However, depending on your financial goals, you may want to save more. Creating a budget, setting up financial goals with timelines, and separating your needs from wants can go a long way toward helping you cultivate the habit of saving.
Tax-free savings accounts (TFSA) are an excellent way to save for both short- and long-term goals, but there is a cap on how much money you can put in it in a year. Other great savings include High Interest Savings Accounts and Term Deposits, while a registered retirement savings plan (RRSP) is an excellent choice for saving for retirement.