The great financial advice given in most personal finance books “Save 10% of your income”.
This might be the first time you’ve ever heard it and like what you’re hearing, I sure did. Over time though, I’ve realized saving only 10% has serious limitations.
Which makes me ask the question… Why 10%? What about 20, 30 or 40% of your income?
Where it started (In my opinion)
I first came across the 10% rule when I started my journey of saving and investing. At first, I thought it was pretty cool. I never considered breaking my income down into percentages and allocating it to where it needed to be.
But then I started hearing it more and more, every personal finance commentator would say “save 10%, save 10%, save 10%”. Which made me start to question the rule, why are they all saying the same thing?
When you start your travels on the road to financial independence, you’ll start slowly by reading a few blogs and a few book recommendations, just developing your skills and knowledge.
While I was doing this and working my way down the personal finance book list, I got to a well-known book written in 1926 by George S. Clason called the Richest Man in Babylon.
What could a book from 1926 teach about modern personal finance?
Turns out a lot. And it’s where I finally read about saving 10% of your income. A book written in 1926 talking about saving 10% of your income, I think I found where everyone got their idea from.
Now that’s not a bad thing if everyone was borrowing this idea. Charlie Munger the Vice chairman of Berkshire Hathaway and Warren Buffets business partner is a big proponent in mastering the mental models of people who came before us and borrowing simple ideas.
I just think 10% isn’t enough for everyone.
Why 10% isn’t enough.
Even though the book was written in 1926 every lesson in the book holds true today. Truly timeless and one of my recommended reads for anyone who’s serious about creating wealth.
It’s just 10% isn’t enough. Actually, It’s enough if you’re looking to put a little bit aside for a rainy day. But it’s not enough if you’re planning to retire early through financial independence, or you’re trying to save for a large asset purchase like a house.
I’ll start with the house as an example using some of the Australian Averages.
The average yearly wage in Australia is around $87,000 a year. The average house price in Brisbane is $577,644 (I went with Brisbane cause that’s where I live).
If I was only saving 10% of this income each year, I would save $8700 a year. Assuming a 20% deposit on $577,644, I’d need to save $115,528.
It would take me over 13 years to save for this deposit. And let’s be honest, I’d be surprised if the average house price in Brisbane was still $577k after 13 years thanks to inflation.
Alright, 13 years is way too long!
So, what if I was extremely frugal and lived well below my means and saved 40% of my income?
I would be saving $34,800 a year and it would take me just over 3 years to save for the deposit. Much easier time frame to achieve.
Investing in shares
What about someone trying to build a portfolio of shares to either increase their cash flow or live of the cash flow it produces.
We’ll use a $1 million portfolio because that’s probably getting to a level where you could retire and live off assuming a portfolio that yields 4%.
If you were to save and invest the same $34,800 every year and you had average returns at 9% a year it would take approximately 14 years to reach a $1 million portfolio.
Using the same parameters of 9% compounded annually, but saving and investing $8700 a year it would take around 28 years to reach $1 million.
If you’re not in a rush and happy to live off the dividends closer to retirement age then not a bad outcome. And you should be thanking compounding for doing a lot of the heavy lifting.
Still, it took double the amount of time and for most people reading this blog 28 years is way too long.
Hang on a second, you’re just using arbitrary numbers
I know, I know I’m just inputting numbers to get to where I need to be. And obviously circumstances change. There can be unforeseen expenses, our lives could change such as having a family or we could get seriously ill.
For investing in shares, It’s worth testing it out yourself to see what numbers you come up with https://moneysmart.gov.au/budgeting/compound-interest-calculator
Another alternative could be someone who earns a high income. If they were earning a few hundred thousand a year they could be okay saving 10%, depending on their retirement goals.
But using the averages I think it’s pretty clear. Saving 10% of your income isn’t enough if you want to retire early.
Why 10% is enough… when you’re just starting out.
Even though I believe 10% isn’t enough, I believe it is enough if you’re just starting out trying to save.
A person who has never saved any money and is just starting out would struggle to save more then 10%. I’ll explain why.
Imagine your someone who wants to lose weight after years of unhealthy habits, you’re going to get a serious meal plan. Just chicken broccoli and rice every meal, and train 6 days a week.
You start off guns blazing feeling motivated and invigorated. But then, 2 weeks in, it starts to get too hard. The foods disgusting and your sore form training and you slowly slip into your old habits. 4 weeks in and you’re completely back to normal, eating junk food and no exercising.
They made it too difficult for themselves, it’s not like them to eat that way or exercise. They need to form the habit first and turn it into their self-image.
It’s the exact same for a new saver. They’ve never saved a cent but want to take it seriously and get to financial independence as quickly as possible. So, they jump straight to saving 40% of their income, the first 2 weeks it’s easy but then it starts to get harder and harder.
They can’t cope with having no money, it feels too restricting. So, they give up all together. Declaring, “this saving thing is too hard”.
If this same person had started with 10%, they would have probably realized they can save. After a while of saving 10% a habit will form and they notice they’re saving easily and could probably add more. After adding more, more time passes and they realize again they could add more.
Eventually this person has started compounding their discipline, habits and their money (if they started investing it of course).
Not all new savers are like this, but if you ever see someone start then stop you’ll know the reason why.
If you’re trying to save and invest to reach financial independence 10% isn’t enough, I think that much is clear. But if you’re just starting out and want to build the habits then it’s enough. Until you get comfortable and can start to save more.
What do you think, is 10% enough?