I’ve learnt to treat questions that include soliciting stock tips and my prediction for the stock market as feeble male attempts to include me in their conversations at social dos. I’d actually much rather talk about dogs, kids and trade hummus recipes. Anyhow, the one question I do take seriously is one which goes like this: I have been investing, but how do I know I am doing enough? How much should I be saving, is there a magic number that I need to hit?
Unfortunately, there is no one single answer to this. The US looks at a 10-12% saving rate very approvingly. But do remember that their national household saving rate is negative, so 10-12% is aspirational. But in India, we save over 30% of household income. So would it be correct to link the magic number to this? I think it would be more useful if we could get an age-linked saving benchmark rather than an average number. I worked on some assumptions to find that magic saving number in the Indian context that would spit out the ideal saving rate depending on how old you are.
The answers first. The “Save Your Age” (I just made that up!) rule of thumb says this: In your 20s save 20%, in your 30s save 30%, in your 40s save 40% and in your 50s save 50% of your post-tax income. While this looks simple enough, I did spend the better part of three days working the spread sheets and grappling with various assumptions to get this number. You are getting the conclusion box of a 50-page paper! The first assumption is that the spending is linked to income levels (we cannot do thumb rule numbers for the exceptions who, at one end, live on credit card debt or at the other, sniff from outside at coffee aromas to get their caffeine kick). Second says there will be financial ability related withdrawals for children’s education and marriage. Third says you retire at 60 but yet earn a fraction of your pre-retirement income till age 70. Fourth says you do not draw down your total retirement corpus during your retired lifetime, but plan to leave an inheritance. You need to be earning between 10-12% a year on your savings to make this model work. Any change from this and you can bump up or down your target savings rate.
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While this remains a rough rule of thumb, two things work in the favour of an accelerating saving target rather than a flat average throughout life. First, savings are difficult to begin, but once begun they quickly become a habit. And as you age, the savings habit only strengthens as increasing responsibility of becoming home owners, growing kids and ageing parents all come together. A flat 30% saving target over the lifetime would needlessly cost a young family its lifestyle, while allowing a mature couple with no kids to indulge, with too large a surplus at age 55. The second reason why this works on the ground is that income tends to also gather momentum after 15-20 years of work. Hyper-jumps in income around the ages of 35-45 are not uncommon as a person settles firmly in his career and the rent of experience begins to tinkle in. The proportion of income needed for basic living—food, clothes, transport, fees and so on—also drops dramatically. One estimate puts post-tax savings in many mature metro families at over 60%.
If saving too little is a worry, saving too much could cost a family its happiness. Benchmarks set you free. They allow you to mentally relax about performance. Once I know I am doing as well as I should, I can make spending on my today guilt free.
Monika Halan is a certified financial planner and policy analyst in the area of financial literacy and intermediation. Your comments and personal finance queries are welcome at firstname.lastname@example.org