The 10% Savings Rule is one of the most important things to understand on your journey to financial independence. One you have mastered and internalized it, you can use that mindset to take things to the next level.
The 10% savings rule is very simple. It states you should save 10% of everything you earn. If you earn $3,000 per month, you save $300. If you earn $5,000 per month, you save $500. And if you earn $15,000, you save $1,500. It as simple to understand as it gets.
All it takes to follow the 10% savings rule is to want to apply it. There are no excuses. If someone is not able to apply it, it is because they have not made it a priority. After all, if you suddenly lost 10% of your income, don’t you think you would find a way to live and make things work?
Pay Yourself First
If the 10% savings rule is so simple to understand and apply, why are so few people following it? It all has to do with the way most people manage their personal finances. Most people get paid their salary, spend money on things they like and, if there is anything left over at the end of the month, that is considered savings. And perhaps those savings are spent the following month.
However, those people who adhere to the 10% rule, or whatever rule they have set for themselves, do not operate that way. The best guarantee to applying the 10% rule is to pay yourself first.
Because discipline may be difficult to maintain, we need to make things easy for us. Consequently, the best way to apply the 10% rule is to put that money away as soon as we get paid. Ideally, we set up a direct transfer that will go automatically from our current account to whatever savings or investment account we have designated.
Having our savings in a separate account removes the temptation of spending that money later on. At the same time, seeing how our savings grow every month will give us a sense of satisfaction that will make it easier to carry on with our plans. A great way to achieve our goals is to track our progress.
Shall we invest it?
The 10% rule focuses primarily on saving that money and doing it no matter what. We want to keep a portion of what we have produced. Once the money has been saved, we can decide whether to invest it or not.
I personally believe that once we have accumulated enough savings for us to feel comfortable about the future, it makes a lot of sense to start investing. We can even automate those investments, so the money leaves our current account and, as soon as it is available in our investment account, it is immediately invested without us having to do anything.
Because we invest the same amount of money every month, we are able to reduce the risk of our investment strategy.
This is because, when the market falls, we will be able to buy at lower prices. When the market goes up and we make profits, we will automatically buy less as prices are now higher.
As we do not know what is going to happen in the markets, investing the same amount of money every month prevents us from making the costly mistakes of investing too much when markets go up and too little when markets go down.
This investing strategy is known as Dollar Cost Averaging and can be done with an exchange-traded fund that invests in the global equity markets. A great option would be an ETF tracking the MSCI World or MSCI ACWI indices.
Alternatively, if you do not want to risk your capital just yet, you can look for a savings account or short-term bond paying an attractive rate of interest.
The 25% Savings Rule
Now that you know the 10% savings rule, you may want to know what the 25% savings rule is. Well, it is basically the same but, instead of saving 10% of our income we save 25%. If you think that is impossible, ask yourself the following: What would I do if my net income suddenly dropped by 25%?
Instead of passively saying that something is impossible, ask yourself how you can make it possible. This phrase was made popular by Robert Kiyosaki. And it is crucial if you want to take full control over your finances.
If you save 25% of your salary every month, you will have saved an entire year’s salary after just 4 years. And this does not consider the returns you could have generated by then if you invest your money.
Your Own Savings Rule
Finally, I want to encourage you to design your own savings rule. A 50% rule, for example, would allow you to save a month’s expenses every month. While I am aware that it would be difficult for a lot of people to suddenly apply a 50% savings rule, action can be taken.
For example, you could look for ways to not only save more, but also earn more. After all, the more you earn, the more you can save. And the real secret to building significant wealth is to combine high earnings with limited spending.
One of the indirect benefits of starting with the 10% or 25% rule is that, as long as you keep your expenses unchanged, higher earnings in the future will automatically lead to much more savings. And the higher your net worth, the more investment opportunities you will have.
I explored this idea of exploding savings in this post:
How to Double your Monthly Savings
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