How Much Should You Be Saving?

Dear Carrie,

I'm turning 30 and know that I need to get serious about saving. How much should I be setting aside?

—A Reader

Dear Reader,

Thank you for this question. The future can seem so far away, and the path to that future so unsure, that it can be difficult to know exactly how much to save… or even to find the motivation to get started. The reality, though, is that the earlier we start to save—whether it's for retirement or other goals—the less difficult the challenge becomes. 

A comfortable, secure retirement is the biggest financial challenge most of us will ever face, so it's smart to put it at the top of your priorities.

The following guidelines are not absolute, but they can give you a reasonable estimate of what it takes to prepare for retirement. As you can see, the earlier you start, the smaller the bite:

• If you're getting started in your 20s, save 10-15 percent of your pre-tax income.
• If you're getting started in your 30s, save 15-20 percent of your pre-tax income.
• If you're starting to save in your early 40s, save 25-35 percent of your pre-tax income—a pretty meaningful chunk of your income.
• If you start later, the percentages add up quickly. So save as much as possible, and consider other strategies, such as retiring later, to manage retirement.

The real beauty of these guidelines (especially for those who are young) is that the percentages won't change as you get older. If you're 30 and can save 15-20 percent of your income for retirement, you probably won't need to save more than 15-20 percent as you age. Starting early is a huge advantage, provided that you remain consistent throughout your working life.

Don't get me wrong. I understand that saving 15 percent of your pre-tax income when you're 25, or 20 percent of your income when you're 30, is tough—especially when you're trying to pay off student loans or manage other financial obligations. But the numbers don't lie—retirement is a hugely expensive challenge, and the earlier you start preparing for it, the better.

Also realize that you can choose to lessen the hit to your current income by contributing to a tax-deductible account such as a traditional 401(k) or an IRA. Alternatively, you can channel your savings into a Roth 401(k) or Roth IRA, paving the way for future tax savings.

Once your retirement savings are on track, it's time to broaden your sights:

• Emergency fund: Make sure you have enough cash set aside to cover three to six months' worth of nondiscretionary expenses. Keep this money in a savings or other liquid account. You won't earn a lot of interest, but you will be increasing your financial security.
• A child's education: If you have kids, I recommend considering a 529 plan to shelter investment gains and income from taxes. The amount you need to save will depend on your income and the type of college (public or private) you envision.
• The down payment on a house: A more near-term goal for many people is buying a home. Given today's real estate market, this is not an easy task. To get the best mortgage rates, aim to save a minimum of 20 percent of the purchase price.
• Other goals: If you have other goals (for example, travel or starting a business), put those on the list as well. Determine the amount you want to save by a particular date, and back out the math.

Once you've determined your savings goals, I highly recommend that you arrange an automatic transfer to your savings or investment accounts each month; that way, you won't have to consciously make the "save or spend" decision each month. A payroll deduction plan is ideal for retirement, especially if it goes into a tax-advantaged plan like a 401(k) or an IRA account. (Your 401(k) plan contributions are often matched to some degree by your employer—making your effective savings rate even higher.)

Finally, understand that "saving" is different than investing. You can't afford to take risks when you're saving for a short-term goal. But when you're striving to meet a goal that is at least five years in the future, it's prudent to consider tapping the potential of the financial markets (particularly the equity markets) to give your savings the chance to grow into wealth. Best of luck!

Have a personal finance question? Email us at askcarrie@schwab.com. Carrie cannot respond to questions directly, but your topic may be considered for a future article. For Schwab account questions and general inquiries, contact Schwab.