Currently, the average savings rate in the US is pathetically low, somewhere below 5% (3.6% when I wrote this). That means that people are saving, on average, 3.6% of their disposable (after tax) income. I like graphs, so let’s take a quick look at the one on the right. Three things pop out to me. 1) Before 1980 or so people saved around 8-10% of their disposable income. 2) After the early 1980s the savings rate started slowly dropping, and dropping, and dropping. 3) Savings rates spike during recessions.
So then what’s the difference between super savers (those with double digit savings rates) and the average person? And how can all of us work to boost our savings rate?
I’ve always been fascinated by people on both ends of this savings spectrum. On one end, we’ve got people who burn every dollar they get and then borrow money to burn more. On the other end we’ve got people who save 30%, 40%, 50%, or more of their income.
Principle 1: Having a high income helps you become a super saver, but it’s not required.
Savings rate by income quintile are shown below(*). Remember that each quintile represents 20% of the population.
- Quintile 1 (0-20K/year): 0.3% savings rate
- Quintile 2 (20-38.5K/year): 2.8% savings rate
- Quintile 3 (38.5-62.4K/year): 6.4% savings rate
- Quintile 4 (62.4-101K/year): 6.2% savings rate
- Quintile 5 (101K+/year): 11.9% savings rate
The top and bottom quintiles make sense. If you don’t make much money, you can’t save very much. If you make tons of money, it’s pretty easy to shovel some into savings. What the hell is wrong with quintile 4? They make more, but save less than quintile 3.
What’s interesting is that none of these savings rates are mind blowingly high and super savers can be found in each income quintile.
When I was in quintiles 1 and 2 (grad school), my savings rate was probably around 2%. It took my entire research stipend just to live a modest life complete with a crappy apartment and walking to school every day. I also wasn’t very well versed in the ways of personal finance back then. When I moved to quintile 3 (post doc training) I saved around 25-30% of my salary. Now that I’m in quintile 5 (real job), I’m trying to save 50%+.
Principle 2: Living in a lower cost of living area allows you to save more money, but it’s not required.
Cost of living is a huge determinant in how much you can save. Different areas have radically different costs of living. The higher the cost of living, the more it costs for the basics (food, shelter, utilities, transportation) and the luxuries. Higher cost of living areas often come with higher paying jobs, but the pay increase isn’t necessarily enough to equal everything out.
Check the map on the left to see where your state puts you. Of course, within states cost of living varies widely as well. The cost of living in Chicago IL is way higher than that in Springfield IL. Which brings us to the next principle of being a super saver.
I’ve lived in high and low cost of living areas. And yes, it is way easier to save money when you don’t have to pay through the nose for a one bedroom apartment.
Principle 3: The more modestly you are willing to live, the more you can save.
You don’t necessarily have that much power to immediately change your income or cost of living. You can work to grow your income or look for jobs in cheaper areas of the country, but that takes time may not even be realistic or desirable.
But there is one aspect of your finances that you have a great degree of control over, and that is your lifestyle. The more that you want to live large the less that you’re going to be able to save. I don’t advocate renting an apartment in some slum populated by drug dealers, hookers, and weekly shootings just to save money. Nor do I recommend surviving entirely on lentils and ramen because they’re cheap. On the other hand, just because you graduated college, doesn’t mean that you need to buy a Lexus. Nor do you need a six bedroom house for a family of 3.
Sit down, look at your budget and make some thoughtful decisions about how much you want to spend on what. Everyone deserves to have some luxuries in their life and everyone has things that they don’t care that much about. Try to match your budget to your priorities and save the rest.
I live in modest luxury. I have a nice one bedroom apartment. I could rent something bigger, but at this point in my life I don’t need that much space. I drive an old, but reliable car, which I intend to keep driving until it finally gives up the ghost. I love food, so I spend a lot on it, both cooking and eating out. I also like to travel and explore so I budget for that. Those are my choices that I consciously made budgeted accordingly for. The worst situation is when you are just reactive, buying whatever you want at the moment because it’s there, without any regard for how it fits into your overall personal and financial goals.
Principle 4: External financial burdens affect how much you can save.
Sometimes we have financial commitments that we may or may not have ever wanted in the first place.
Perhaps we have to take care of kids, non-working spouses, or our aging parents. These circumstances can bring us joy and happiness, but they also cost money and thus limit our savings.
Then there is all kinds of debt – consumer debt, mortgage debt, and student loan debt. Consumer debt is the most onerous of the three, because of the high interest rates and the fact that you probably didn’t need to buy any of that crap in the first place. Mortgage debt is a problem if you buy way more house than you need. The more money you put into housing payments, the less you have left over to build passive income streams. Then there are student loans. These can be great investments if the result is a high paying job that you love. Or terrible investments if the result is no job or a career that you hate.
Currently, I have no financial commitments. A fact that I am very thankful for.
If you want to become a super saver, focus on these four core principles. Everyone’s situation is different, but most of us can and should be saving more. Especially if we want to become financially independent. Every bit of income that we can save is one step closer to achieving financial independence.
- Make a high income (I’d recommend high five figures at least).
- Live in a low cost of living area.
- Keep your lifestyle modest. Live like a new graduate who just got their first job.
- Minimize financial commitments.
(*) This data was kludged together by combining 2011 tax data and a 2004 study by Dynan et al.
Readers: Are you a super saver? Do you want to become one? Do you agree with the four principles proposed here? Would you add any? What are your secrets to saving tons of money?