I subscribe to Andrew Sather’s The Investing For Beginners Podcast where all topics of stock market and personal finance are discussed in great details. In the most recent episode, Andrew discussed a list of “the worst financial advice ever given in the history of mankind” and he ranked investing 10% of your income as #1.
WTF? I thought I’m supposed to save diligently at least 10% of my income and invest wisely. That’s why I try to save over 50% of my income every month!!
Well it turns out, there are 2 ways of saving and choosing the right one can mean the difference between happily building up a nest egg and living a stingy and miserable existence.
The 2 ways of saving
Broadly you can choose to:
- Invest a fixed amount of your income per month
- Invest a fixed % of your income per month
It’s important to remember that these 2 methods are interchangeable because you cannot mathematically save more than 100% of your income, so whatever you save, it will always represent an amount that is a % of your income.
When I first graduated 6 years ago, I saved £500 per month on a (sole) salary income of £2,000. This represented a 25% saving rate.
In March this year, I generated a net income of almost £7,600 and saved £4,400, achieving a 61% saving rate.
In both cases, I saved an amount which also represented a % of my income.
Saving a fixed amount works best if your income is low
When I was making £2,000 per month, I had to pay:
- £200 for property tax and utilities
- £300 for food
- £200 for transport
These were essential and unavoidable living expenditures and took up 35% of my income.
However that amount remains practically unchanged when I made £7,600 last month (OK, transport went up by £50 and food up for £100 because I had 2 mouths to feed). Thus these expenditures only occupied 11% of the income.
Clearly saving 57% of my income when I was on £2,000 was not realistic whereas saving 57% when I was on £7,600 was very achievable.
Consequently if you income is low then you should probably aim to save a fixed amount per month.
Saving a fixed % is great for wealth building if your income is rising
I decided to switch from a fixed amount to % when I started to make more than £4,000 per month. My initial target was 20% of my income but I started increasing the target to 50% as my income rose.
My current target saving rate is around 50%. Ideally I’d like it to be at the 65% range but with the coming of WB40 Junior and the associated rising expenditure, 50% is a perfectly fine target.
The benefit of setting a % target is that my saving will increase alongside with my income and a portion of every incremental £ increase will be saved and invested into my portfolio. This means my rate of capital increase will be in line with my rate of income increase, which allows greater exposure to the market. That is great for long term wealth building.
The unintended is that I have financial flexibility if my income ever falls. I’d simply save a bit less in absolute terms.
At the end of the day, it is all fine whichever way you go as long as you are living well within your means and saving / investing the surplus wisely.
To leave you with a finishing thought: you can only save 100% of your income but you can increase your income towards infinity.
Which way are you leaning towards? Would love to hear your thoughts. Please comment away.