This month’s question is from Christina Skinner, who is completing her PhD in Marine Biology at Newcastle University. She studies the ecological connectivity role of predators on coral reefs. Interesting, right? Tina also asked: How can I be sure I’m saving enough? How will I know it’ll be enough for when I retire?
That’s a very important question, Tina. What makes financial planning especially tricky is that it may be too late by the time you realise you’ve been doing it wrong. Given its importance, we find it hard to understand why they don’t teach us financial planning at school. Thinking about these things at 29 years old puts you ahead of many people, so thank you for asking! Before starting Curvo, we had the same question and we will try to give you the best answer given our knowledge and experience.
Start with an emergency fund
Before starting to save for the future, we advise to first set money aside in an emergency fund. Its purpose is to provide a safety net in case of unexpected events: you lose your job, your car breaks down and needs a costly repair, there’s a leak in your house and the plumbing needs an overhaul, etc… Without an emergency fund to tap into, such events can force you to take out a loan at an exorbitant interest rate. And avoiding debt is the first rule of responsible financial planning.
We advise the emergency fund to be about 3 to 6 months of your monthly expenses. So if you spend around €1,000 per month, setting aside €3,000 to €6,000 is fine. Furthermore, it’s important to not invest any of this money. Just put it on a savings account so that you can access it whenever you want.
Once you have your emergency fund set up, congratulate yourself and enjoy the peace of mind that comes with it. Unfortunately, too many people live pay check to pay check and are not aware that they could get in financial trouble in case of unexpected events.
The rule of 25
Now let’s look into how much you should be saving. The“rule of 25” says that you need 25 times your yearly expenses saved up to live off of your savings. This number takes into account a moderate return on your savings as well as inflation, possible economical downturns, etc… For example, imagine you want to pay yourself €2,500 per month during your retirement. Assuming you are not getting a pension, the rule says that you need to have €750,000 saved up (25 times the yearly expenses) by the day you retire.
That’s a lot of money! Fortunately in Europe we have state-funded pension systems that supply a big part of your income at retirement. Let’s pretend that the UK pays you a pension of €2,000 per month (and that they reverted Brexit and joined the euro in the mean time 😀). You will then only need to supply €500 per month of your own money. In that case, the amount you need to have saved up by retirement drops to €150,000. That still looks like a lot (it is!) but it is definitely achievable by wisely investing your savings and have the money work for you. For instance, if you set aside €500 today and invest it in a fund with a 6% yearly return, it will have grown to €4,073 by the time you’re 65.
The rule of 25 is useful if you know how much you will be spending after retirement and how much your pension will be. However, those things are unknown at your age. So let’s look at it from a more practical angle.
20 percent is the target
A good rule of thumb is that you should aim to be saving about 20 percent of your income when you’re around your thirties. Of course, everyone’s financial situation is different so don’t stress if that’s not realistic for you now. Saving something is better than nothing.
Tracking all our spending for about 3 months helped us a great deal in getting a picture of our financial situation and we advise everyone to do the same. Some banks offer such tracking through their mobile apps. Otherwise, you will have to keep track manually. Once you know how much you’re spending every month, you can easily calculate how much of your income you can save. Additionally, it will give you great insights in how you can reduce your spending. Figure out what expenditures really are important to you and try to reduce spending money on things that don’t add much to your life. Maybe you will find out that you’re spending a lot on eating out. Start by reducing your outings to restaurants. On the other hand, if you’re a food lover, you might want to keep spending money on restaurants because you enjoy those times so much!
Once you have a clear picture of your monthly budgeting, settle on a first savings rate that you’re comfortable with. It’s OK to start low, for example 5 or even 2 percent. From then, you can gradually increase it every few months. It’s fine to decrease it whenever you feel that you don’t have enough spending money to get through the month. Through it all, keep that 20 percent goal in mind. It’ll keep you from getting complacent. Also, whenever you get a raise, make sure to increase your savings rate accordingly.
“Do not save what is left after spending, but spend what is left after saving.”
This quote by Warren Buffett, the most successful investor of the last 50 years, sums it up. Aim for a 20 percent savings rate, but don’t feel bad if your current situation makes that impossible. The most important is to be saving as much as you can, while still being able to spend money on things that matter to you.
I hope this answered your question Tina, and please let us know if you have additional questions!