Saving and investing are two key aspects of building a strong financial foundation that will support your future. Saving can help you deal with unexpected expenses and afford your goals, while investing can help build wealth over the long term. But when it comes to your regular paychecks, how can we make sure these smaller figures work the best for you?
We know saving and investing are important, but it can be hard to stay motivated and on track when you are unclear how much you should actually be saving and investing.
Here are some tips to help you figure out how much you should be saving and investing out of each paycheck you receive.
Do a Financial Checkup
Before deciding how much of your paycheck should be allotted to savings or investing, first see where you’re at with a financial checkup. This is an important part of the process, as there are no cookie-cutter answers or one-size-fits-all solutions; it really depends on your situation.
Consider the following:
- Are you currently in debt?
- Do you have an emergency fund with three to six months’ worth of expenses? Even more if you are self-employed?
- What are your short, medium and long-term goals?
- What percentage of your income can you live off? If you can live off 50% of your income, you can theoretically allot the other 50% to saving and investing.
- At what age do you plan on retiring?
It’s key to gauge where you currently are in order to map out where you want to go. From a financial standpoint, you’ll want a strong financial foundation that allows you to focus on saving and investing. Saving and investing helps build your financial future, but that shouldn’t be your focus if you’re currently living paycheck to paycheck or are in debt.
If you are in debt, you’ll want to put your extra cash toward paying that off first, as it’s a guaranteed return on your investment.
Aside from your current financial status, consider your age, lifestyle and goals when thinking about saving and investing. These factors will all play a prominent role in how much you should save and invest.
Be Clear About the Why
Saving and investing are tools for building your financial future that can help you achieve your goals. But in order to be motivated and figure out how much you need to save and invest, you need to be crystal clear about the why.
What is your purpose for saving and investing?
Savings can take on multiple facets. Of course you should have an emergency fund with liquid cash available for when those inevitable surprises show up at your door, but aside from saving for emergencies, think of what you need to save to achieve your goals.
Some common savings goals may include saving for a down payment on a house, paying for your children’s college education, or that once-in-a-lifetime dream trip.
Think of your savings as divided into various buckets for each of your goals. To help ground this idea, you can use something like Capital One 360 (which I personally use) and create up to 25 savings accounts you can nickname to match each goal.
Come up with fun names like “Our First House,” “The Bucket List Trip” or the “I’m Never Working in an Office Again” fund. The point is to have fun with it and keep your savings goals clear. These savings buckets have kept me in check with my goals and what I want. When I used to have all of my savings in one lump sum, it was hard to differentiate between my goals and clearly think about what the money was for. Now, there’s no confusion!
In regard to investing, think about what your goals are as well. How much of a nest egg will you need to retire? Do you have an idea of when you’d like to retire? Are you content with working until you are 65 or do you want to pursue early retirement? Understanding where you are financially and what your goals are will help guide you.
Come Up With a Plan
After doing a financial checkup, and figuring out your goals for saving and investing, it’s time to create a plan that puts your money into action. The first step is to look at your income and expenses. How much do you bring in each month and how much of that are you spending?
The less you spend, the more money you’ll have left over to allot to saving and investing. For example, if you currently spend 70% of your income each month, you’ll have 30% of your income left over. Depending on your goals, you could put 15% toward savings and 15% toward investing. If your emergency fund is fully funded and you have no immediate short-term goals, you can continue to save a small amount, such as 5%, and invest the 25%. It all comes down to your goals.
“Whenever a client asks me for an estimate of what they should be spending in a certain budget category or saving each month, I immediately ask them about their financial goals. It’s crucial you know what your goals are and what they’ll cost you. I’m not going to tell you to save 10% of your income and have you find out later that you couldn’t meet your goals. Find out what you need to save for, budget for it and make it happen. Don’t “save 10%” and find out later you completely underestimated your goals,” states Adam Hagerman, a Certified Financial Planner and financial coach.
The beauty of personal finance is it is personal. While personal finance experts may extol the benefits of saving 10%, only you know what will work for you. If you want to pursue financial independence, a 10% savings rate isn’t going to cut it. If you feel unclear about what direction to take in regards to saving and investing, consider talking to a Certified Financial Planner.
“I get asked about retirement savings quite often. Should you save 10% of your income? 15%? Should you strive for $1,000,000 in your portfolio? Only you know the answer to that question. If you know what you want to do in retirement, go and talk with a licensed Certified Financial Planner professional,” Hagerman adds.
So when you’re coming up with a plan for how to divide your paycheck, keep your goals and values in mind and let those things inform your plan. It’s also important to remember things are not set in stone and should be re-evaluated with any big life changes like pay increases, layoffs and more.
Anjali Jariwala, a Certified Financial Planner and founder of FIT Advisors, discusses the delicate balance of saving and investing, stating:
“The balance between savings and investing is more of an art than a science. However, there are some rules of thumb to help navigate this important yet sometimes difficult concept. I recommend clients allocate their disposable income based in the following order:
- Investing: Employer Retirement Plan
- Savings: Worst-Case-Scenario Fund
- Investing: Roth IRA or taxable investment account
I always recommend contributing up to the match on your 401(k), otherwise, you’re leaving free money on the table. Once you contribute up to the match, building a savings bucket equivalent to 6–8 months’ worth of expenses is necessary. I call the savings bucket the worst-case-scenario fund because if the worst case happens, like losing your job, you have six months of cushion to live off of. Once this is set up — invest, invest, invest!”
Aside from these important guidelines, it’s key to focus on your own personal financial situation when coming up with a plan. Create a plan that works with your goals and your current financial situation. Anjali Jariwala offers a great example:
“The balance between the various buckets will vary based on a person’s financial situation. Let’s take an example. Sally is a young professional with $50,000 in student loan debt. She is able to contribute up to the match on her 401(k) and after all of her expenses including her student loan payment, she has about $500 a month left over. Sally should save the $500 to build her savings fund. If she has any money left at the end of the year, she should consider opening up a Roth IRA. In this situation it is more important for Sally to build her savings fund than it is to invest her remaining income. She already has a forced investing mechanism which is her employer 401(k) account.
“On the other hand, a financially stable couple may have a completely different profile. Bill and Amy are a couple in their late 30s and earn in total $200,000 a year. They have about $150,000 in savings and their monthly expenses are $10,000 a month. Bill and Amy should max out on their employer 401(k) accounts, keep $60,000–$80,000 in savings and invest the remaining money. Since they are financially stable they should invest so the money earns money for them. Even if the markets take a hit, they have a long time horizon before retirement to weather any storms.”
As you can see, how much you should save and invest will vary person to person, and there is no one blanket answer for everyone. The key is to have enough liquid cash to deal with unexpected emergencies and to fund your life goals, while investing the rest and taking advantage of time and compound interest.
How much of your paycheck do you save and invest?