How much money should you save every year? This is a question that many people ask, but it can be challenging to answer. The amount of money that you should save depends on your circumstances. However, there are some general guidelines that you can follow. This blog post will discuss how much money you should save each year and give you some tips on reaching your savings goals!
Saving money is essential for many reasons. It can help you in case of an emergency, allow you to buy the things you want, and make it easier to retire when you’re older. But how much should you save every year?
The 50/30/20 Rule
One general rule of thumb is the 50/30/20 rule. This rule says that you should spend 50% of your income on necessary expenses, 30% on discretionary expenses, and 20% on your financial goals through saving and investing. This rule can be a good starting point when figuring out how much money to save each year.
Necessary Expenses (50%) can include:
- Mortgage Payments
- Rent
- Food
- Utilities
- Transportation (If required for essential trips and commuting).
Discretionary Expenses (30%) can include:
- Subscriptions
- Gym Memberships
- Eating Out
- Outdoor & Indoor Entertainment
- Alcohol
Financial Goals & Investing (20%) can include:
- Cash ISAs
- Stock & Shares ISAs
- Lifetime ISAs
- Pension Accounts
- Trading Accounts
- Asset Accumulation (Property, Stocks & Shares, Bonds, etc.)
The 50/30/20 rule is a good starting point, but it’s not the only factor to consider. You also need to think about your circumstances. For example, if you have a lot of debt, first focus on paying this down. This is by far the best decision you can make, as often, the interest you pay on loans and credit card debt can far exceed the returns you would receive on investing your money.
If you’re trying to save for a specific goal, like a down payment on a house, you may need to save more than the 20% guideline. You may also find that your circumstances don’t allow you to reach the 20% guideline. This is perfectly fine – get as close to the 20% as you can – savings something is better than nothing!
What are you saving for?
Good question.
Well, this again depends on you as an individual. You may want to save for goals in the immediate future, but we want you to secure your financial freedom here. Financial goals shortly will keep you sane, and you should never give up on the things you love. No goal is worth making yourself miserable (this is not to say that there won’t be sacrifices).
The Four Percent Rule
This is where the “four percent rule” comes into play.
The “four percent rule” is a guideline that suggests you withdraw no more than four percent of your portfolio each year during retirement or, in this case, “early retirement.” We will call this financial freedom as the primary purpose is to provide you back with your time – you still need to fill this time with the things you love, or you will be sure to lose your mind!
William Bengen, a financial planner who wrote a landmark paper in 1994 on the topic, popularized this rule of thumb.
Bengen’s research showed that if you started withdrawing money from your portfolio at a rate of four percent and then adjusted that amount for inflation each year, your money would last for at least 30 years in almost every historical market scenario.
How much money do you need to save every year?
The “four percent rule” means that you must save 25 times your annual expenses from becoming financially independent. This value comes from 100 divided by 4 to make the total balance to be withdrawn from.
Technically, as long as your portfolio grows quicker than your withdrawal rate, you can indefinitely live off your portfolio.
The “four percent rule” is just a guideline, not a hard and fast rule. No guarantee following this rule will allow your money to last indefinitely. But it’s a good starting point for figuring out how much you can safely withdraw from your portfolio each year in your drawdown.
Of course, the “four percent rule” assumes that you’re invested in a diversified mix of stocks and bonds and that you rebalance your portfolio periodically.
You can use this calculator to give you an overview of how long your savings will last.
How long will it take?
Remember that you are not calculating your financial freedom on your total salary but on your expenses. For this reason, the lower your costs, the more achievable your goal. If we account for a five percent annual return on your investment, you can expect the below time scales. The below has not accounted for inflation rates and has not included any money you already possess. You can use this calculator to include these in your calculation.
| Percentage Of Income Saved | Years Required to Save 25 Times Your Income |
| 5% | 67 |
| 10% | 54 |
| 15% | 46 |
| 20% | 41 |
| 25% | 37 |
| 50% | 26 |
| 75% | 21 |
| 90% | 19 |
Not happy with what you see, or maybe you are pleasantly surprised. Let’s see what we can do to speed up the process. Bear in mind that this is to reach your existing income – if you reduce your expenses, you can reach your goal sooner.
What methods are there to get to the summit faster?
Employer Match
Firstly, if you are employed, you must ensure you take advantage of your employer’s pension match. If you are not depositing the entire matched amount your employer offers, you lose out on free money.
If your employer offers a six percent match, make sure you deposit six percent of your wage. This will mean that you only need to save a further eight percent to achieve the guideline of twenty percent. If your employer has an even better match – you guessed it – match it.
As your pension is also a tax-efficient account, this is one of the best places to start your journey to financial freedom.
Tax-Efficient Accounts
Secondly, make use of ISAs and SIPPs. These accounts have special tax breaks, meaning you can save/invest more money each year.
For 2021/22, you can invest up to £20,000 into an ISA, which can be a mix of cash, stocks, shares, or even peer-to-peer lending. There is no tax on any money you make inside the account (provided it is from capital gains or dividends), and you can withdraw it without penalty.
You can also invest up to £40,000 into a SIPP each year. This pension account has more investment options, including commercial property. The tax benefits are also very generous, as any money you contribute is deducted from your taxable income (up to the £40,000 limit).
The government will then top this up by 20% if you are a basic-rate taxpayer, 40% if you are a higher-rate taxpayer, and 45% if you are an additional rate taxpayer.
For example, if you contribute £80 per month to your SIPP, this will cost you £960 per year. However, as a higher-rate taxpayer, the government will also contribute £384, making your total annual contribution £1344.
This is a considerable saving as you have only had to find £960 from your salary, rather than the full £1344.
Pensions and ISAs should form the core of your investment strategy as they offer fantastic tax breaks, but there are other options available.
Increasing Your Return on Investment (ROI)
The figures above were based upon an annual ROI of five percent. You can invest in riskier asset classes if you are further away from your retirement age. By doing this, you can gain a higher ROI on your money. Although this is the case, there is a greater risk of losing your invested capital. This could be an option if you are in your 20s & 30s and are not weighed down by dependents and obligations. This could also be for an individual who has already achieved the 20% rate as per the specified guidelines in a less risky asset class.
With the average annual ROI of the S&P500 being approximately 10% since inception & 14% over the last ten years, it is achievable to increase your ROI above the 5% specified. This can quickly be done by investing in an index tracker for the S&P500. Invest every month and forget that the account exists.
Other investment options are available to you, but we will discuss them in another article.
Supplementary Income
You can always support your finances with passive income streams. This is money that you earn without trading your time (once initially set up). For example, you could rent out a room in your house on Airbnb or generate income from a blog through advertising and affiliate marketing.
Supplementing your drawdown with even a small amount of passive income will quickly help you reach financial freedom.
Final Thoughts
By following the steps above, you can increase your savings rate and achieve financial freedom much sooner than you thought possible.
Saving money can be difficult, but it’s essential to start somewhere. By following these guidelines, you can ensure that you’re on the right track to reaching your financial goals!
How soon will you be able to achieve financial freedom? Let us know in the comments below.
What are your tips for saving money each year? Share them in the comments below!
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If you want to learn more about saving money, check out our blog post on “How to Save Money Each Month.” This post gives you tips and tricks on cutting costs and saving money each month. Stay tuned for more helpful blog posts from us!
Not sure where to start with investing your time and money in assets?
Check out the Invest area of The Long Commute.
Need to free up some extra cash and gain a secure foundation before you start to invest in assets?
Check out the Saving area of The Long Commute.
Need to increase your income and build another stream of income?
Check out the Hustle area of The Long Commute.