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Personal Finance - Investing
Written by Karl Wolf   
Tuesday, 16 February 2010 22:38
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How much should you save? That's the question many people ask themselves each year. Some people have golden rules such as 10% of salary while others fixate on a specific amount, for example $500 a month. How to measure it also varies. Some people include retirement funds while others exclude them. While there is no right answer that fits every one's goals, here are my thoughts on what a typical professional with good income making $100,000 should be saving. For those of you short on time, there is a summary chart on the last page.

Emergency Fund:

Every person should have an emergency fund and this comes first. For younger people that are saving up for a house, your emergency fund might evolve over time into your housing fund. Just make sure that when you buy that home that you have something left in the emergency fund to pay for the hot water heater or the inevitable problem with the roof. In my mind, your emergency fund should never be less than $10,000 and should ideally be equal to six months of your expenses. Frankly, I prefer a year's worth of expenses, but at that point, much of the emergency fund will get invested like your normal wealth building account. For most people six months should do the trick which if your expenses are $60,000 a year means saving $2,000 a month for 15 months!

Home Down Payment:

Not everyone should buy a home, but if you are planning on it, you should be saving an amount of money that will let you save a 20% down payment within 5 - 7 years. So if you are living in an expensive place where the 20% is $60,000 or more, you need to be saving at least $10,000 a year. If that sounds like a lot of money, then you should either lower your expectations, increase your income, or live cheaper. Let's face it, almost everyone buying their first home that isn't rich will sink nearly every dollar into the down payment, closing costs, and subsequent furnishing. It's just human nature that the moment you have your down payment in hand is the moment you will spend every weekend going to open houses. Assuming a $60,000 down payment saved over 5 years, equals $1,000 a month. Any interest that you earn will just go to cover the closing costs.


College Tuition:

Once you have your emergency fund squared away and your house bought, it's time to put together some money for the kids college fund. Hopefully you will have a dozen or more years to save. If your kids are in the sixth grade before you start thinking about college, you are going to have to put some serious money away. The problem is that nobody knows how much your kid's education is going to be and everyone will scare you into thinking it is a monstrous number on the order of your mortgage. Could be, but most likely it will be less because your kid is going to pay for some of it too and they can also take a moderate amount of loans. My method was simple: $200 per child per month after they hit Kindergarten. After a few years, I bumped it up to $225 and then $250 as my income grew. Invested in the stock market, we ended up with about $40,000 a kid. That was plenty and covered about 75% of the tuition. The balance was student loans and work. So call it $250 per kid per month for a dozen years.


Retirement:

The amount of money that you need for retirement varies widely. Some people can do it with less than $100,000 with a good pension and health benefits and others won't be able to live the lifestyle they want in retirement with less than $2 million in their 401k. My simple advice. Max out your 401ks every year and spend a few hours each quarter thinking about what your money should be invested in. You can always dial back on your 401k if you think that you have too much in it but it's hard to go the other way. Anybody that puts less than whatever your company matches is a fool. Getting an instant risk-free 100% return on your money is something that never happens anywhere else.

So plan on at least $1,250 a month (15%) towards your retirement. Taxes are deferred so this one isn't nearly as harsh as it seems.

 

Investment Account

Yup, there is another account that you should have, and if you are successful, this will be the one you enjoy the most. I put it last to show you how many other obligations you will have. If you have an account that you deem to be your "Investment Account" but you don't have all four of the above accounts taken care of, your underestimating your liabilities.

If you have the others taken care of, this account is where the true wealth gets built up. The amount that you put into this account is discretionary but guide yourself by what you ultimately want to have for "disposable wealth". You can do anything you want with this account: buy a business, give it to charity, use it to take 3 years off and travel the world, make investments into real estate, or just ride through life with the comfort of having a six or seven figure account that you may ultimately pass on to the next generation. The beauty of this account is that it isn't associated with any liability. It is your reward for living below your means for many years. It therefore allows you to invest it more aggressively than your other accounts.

How big should it be? I suspect most would be happy to have this account be $500,000 or more. If everything else (home, retirement, tuition, emergency) is taken care of and you have another half a million dollars to do what you please with, most of us will feel both sucessful and comfortable. Of course, some of you might want this to be $2 million or maybe $5 million but you aren't likely to get to that level merely by saving on an average income.

So if you want to get there in twenty years, you'll need to start saving about $750 a month and invest it in an index fund or individual stocks. Double it if you want to ensure that you have $1 million.

 

So in summary on a monthly basis, here's what you would need to save at $100K income.

  • Emergency Fund: $2,000 a month for 15 months
  • Downpayment: $1,000 a month for 60 months (assumes $300,000 home)
  • Retirement: $1,250 a month until you stop working
  • Tuition: $250 to $500 a month depending on the number of children
  • Investment: $750 a month until you stop working or have enough
  • These don't all happen simultaneously, the chart below gives a more realistic picture about how much you really need to save and when.

 

How_Much_to_Save

 

Over a ten year period, the numbers average $2,375 a month which is roughly 28% of income. Half that amount on average is going into retirement.

Now most people will say there is no way they can scuttle away 28% of their income after paying taxes, rent or mortgage, etc. Well, if you make about $100,000 a year, the only way you will achieve this kind of wealth and security is by living cheap on everything else you do. Sort of what we talk about at LiveCheap.com!

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