How do I determine an appropriate savings rate?

Posted by on May 18, 2010 in General Information

The word “de-leveraging” came and went in about 2 months during the credit crisis. An initial upswing in the household savings rate seemed to be a blimp and not a pattern. After a short period of  frugality,  Canada’s savings rate fell to 4.6% in Q1 2010 according to Statistics Canada (it was in the 6% during the late 90′s) and the American personal savings rate has seen a downward trend from over 5% in early 2009 to slightly over 3% in Q1, 2010 (back to the approximate range of 2004 rates).

There has been a lot of focus on stock allocations and risk in the last few weeks arising from Greece and the larger sovereign debt issues but the fundamental issue continues to be the same.

People are not saving enough. Household debt levels continue to rise while personal savings rates continue to fall (although household debt levels include both mortgage and non-mortgage debt which raises the question of whether real estate valuations can support our debt- a subject of another post).

But what exactly is enough savings? The figure of 10% of take-home pay has been often used as a nice round number as an ideal savings rate. The only issue with the 10% rule is that it lacks context. Studies have shown that household savings rates are influenced by factors such as interest rates, inflation, the government’s fiscal position and ratio of household net worth to personal disposable income.

When all these factors are aligned positively for the average household, the savings rate can fall and is generally seem as acceptable. Whereas when these factors are affecting households negatively, household savings by necessity must rise.

For example, during the 1960′s, a low inflation/high growth period, the savings rate for Canadians was 6.7%. In the 1970′s and early 1980′s, a high inflation/stagnant growth period, the savings rate for Canadians was in the teens and peaking at 20% in 1982 when mortgage rates were regularly between 15%-20%.

The particular issue facing all of us is that we live such economically anomalous times. Typically, savings rate tend to shot up in down times as a defense mechanism (this is why government in the past could safely increase debt- there was enough domestic personal savings to purchase the debt but if the government and its citizen are broke…). This does not seem to be happening based on recent data. Only one factor- low interest rates- seems to be aligned for consumers which would mean household saving rates should be going up but its not.

Thus, looking at savings rates today and using it as a peg, may not be very helpful and given no one knows what will happen when government turns off the taps, it is hard to predict what exactly an appropriate savings rate should be.

In such uncertainty, the only safe rule seems to be: (i) save; (ii) make it automatic; (iii) save more than you think you need since it is easier to go backwards than forwards.

In that vein, rather than buy an iPad, you can win one at Where does My Money Go. Enter now to win an iPad. Good luck.

5 Comments on How do I determine an appropriate savings rate?

By Future Money-Bags on May 18, 2010 at 6:19 am

I am always pulled towards subjects of saving, since I consider myself to be quite good at it. I am very strict on myself, and budget like the opposite of many people; ‘Like there IS a tomorrow’. I say this because many people I am associated with tell me that what if there is ‘no tomorrow’? Meaning that they want to have as much fun as they can due to the reason that they are unaware of their future.

Well any time I see someone talking about saving, or finances, or budgetting, I pipe in. Saving a minimum of 50% of all AFTERTAX money is my budget plan. On average I save 70% of aftertax dollars, and this is not hard for me.

Saving for your future is important for anyone and everyone. If your 20, 40, or even 60, its not too late to start saving. ‘Pay Yourself First’? I have been doing that for years, before I recently learned that that is the most common saying in the financial Industry. It just makes sense to save what you don’t really NEED.
Seperate your WANTS from your NEEDS, and learn to want things that you need.

On the other hand, if everyone saved just 10% of their income, that would make a huge difference. Lets do a very very modest example, of what a tiny big can turn into through a few years:

If you make $2,000/month after tax, and you save just 10% each month, how much do you think you would have after 30 years? (with an 8% ROR).

Answer: $300,000

Imagine saving 20,30, or even 60%?

By Matt on May 18, 2010 at 9:57 am

Increasing your entries for Preet’s giveaway??

When was the last you did a giveaway with your ad revenue?

By WealthWebGuru on May 18, 2010 at 10:45 am

I could not agree more. Here are my principles of saving:
1. It’s never too late to start.
2. Something is better than nothing
3. Make it automatic
4. The more the better.
Thanks for the great post!
Jim

By admin on May 18, 2010 at 10:50 am

Matt- Shamelessly yes. My ad revenue is negliable but I will think of a give-away in the near future.

By 20 Cents from May 2010 | Balance Junkie on June 1, 2010 at 6:06 am

[...] 8. Thicken My Wallet asks the perennial “How much is enough?” question in How Do I Determine an Appropriate Savings Rate? [...]

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