How savings rate influences your retirement

My savings rate

We all make money from different sources. Most of us are simply earning a salary. A few of us have our own companies from which we also draw a salary. The lucky few, even have their own companies that earn money without their presence. That’s the dream. Irrespective of where your money comes from, you need to put away some of it for your future. A good way of measuring how much money you are keeping is by using your savings rate.

Your savings rate is how much money you have left at the end of the month. The simple way of calculating your savings rate is dividing your savings or investments for the month, by your income after tax. Global savings rates are dependent on a lot of factors. One of which is the interest rate. Higher interest rates encourage people to save as, they know that they can get back more when they invest the money. The savings rate is also higher in countries that earn more or have a culture of saving, like China.

My savings rate for the year so far is 20%. This is way lower than I would like it to be. Granted, I got married in May and had to pay for a wedding, so this average saving should start picking up. One of the expenses that I feel you should add to your savings is your net debt repayment. In other words, the amount that your debt decreased during the month. For instance, I still owe about 50% of the value of the property we live in. Every month I pay R8 200, and the monthly interest on the loan is R6 900. So, every month my outstanding amount decreases by R1 300. This R1 300 I add to my savings as it is a growth in my net worth. Adding my net debt repayments, increases my savings rate to 23.7%.

International savings rate

How does my savings rate compare to international standards? For now, I’m going to ignore China, trust me you don’t want to hear their savings rate. Let’s rather look at the situation we are finding ourselves in. The most recent savings rate in South Africa is 13.8%. To be honest, this is much higher than I expected. The savings rate in the United States is 17.3%. According to this, I’m slightly ahead of the curve.

The question I want to ask today though is, how long you need to maintain a savings rate in order to retire? I assumed that you would be able to grow your savings by 11% per year. I then assumed that you would be financially independent when you have 300 times your monthly salary as discussed in the previous article back-testing the 4% rule. Using different savings rates and determining how long you would need to invest, I drew the graph below:

Calculating my own retirement horizon

This graph will help us to determine how long we need to work before we retire. At a savings rate of 13.8%, the typical South African will need to save for 43 years before they can retire. You will need to start saving at 22, when you are done studying. This will allow you to be financially free at exactly retirement age. With the 23.7% I’m saving I should be able to retire in 35 years. I’ve been saving since I started working in 2011. Theoretically, I should be able to retire at the age of 57, which sounds like a million years away (being 30 now). I’m a bit ahead of the curve and at the rate I’m going now, should get there at age 53. My goal is 45. Do you know of any banks that are easy targets?

Remarks on savings rate

While doing this calculation, four things jump out. Firstly, it is highly unlikely that you can save for your retirement in less than 20 years. In other words, realistically you need about 30 years to save for retirement. So, start sooner rather than later. Secondly, it is very difficult to save yourself rich (although obviously not impossible). My advice is that you should have a second source of income. Be it freelancing or starting a side hustle (I will do a follow-up article on how to identify the perfect side hustle). This will allow you to increase your income to spending ratio significantly. Granted, you will need to keep your living costs constant.

Thirdly, retiring with the same income you earned during your working years will be difficult with a savings rate under 10%. You will need to plan on reducing your living expenses during retirement. Alternatively, you can look at a part-time position to supplement your income. Lastly, increasing your savings rate is effective when you are saving a small percentage of your salary but less effective when you are already saving a large percentage of your salary. When you increase your savings rate from 10% to 40%, you reduce your time to retirement by 23 years. In comparison, when you increase your savings rate from 40% to 70%, your time to retirement is only reduced by 7 years.

It looks like saving 40% of your income is the goal. Time in the market will do the rest. Saving significantly more than 40% will not reduce your time to retirement by much. This will allow you to enjoy life while saving aggressively for your retirement. We don’t know how long we have but based on the average lifespan, you should make it to a carefree retirement without sacrificing your quality of life today.

Be safe out there,

Hendrik

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