When It Comes to Saving Money, What Is a Good Rule of Thumb?
Find out just how much of your income should go toward savings.
Contributing Writer at Tally
January 4, 2022
There are so many financial rules of thumb in the world today, but what about savings? Is there a sweet spot when it comes to saving money that’ll help you get ahead in life and meet financial goals without putting a massive strain on your budget?
Yes, there are many ways to help you build your savings, whether it's for retirement, a new home or a new gadget, without taking away from your necessary expenses. And the great thing is, saving money is flexible, so these rules of thumb can bend to meet your needs.
So, when it comes to saving money, what is a good rule of thumb? Find out below.
What is a good rule of thumb for saving money?
There's no shortage of rules of thumb for savings, but one has remained an accepted rule for many years, and that's 20% of your pre-tax income should go toward savings.
This follows the old 50/30/20 budgeting rule, where:
50% of your income goes toward your needs
30% goes toward your wants
20% goes toward your financial goals, including savings
The great thing about this rule is you can easily bend it to fit your budget and financial situation. So, if you have more expenses, you can adjust your savings to fit and slowly modify your spending until you reach the prescribed 20% savings.
Also, those "financial goals" don't include just savings. There's also debt repayment and other goals you can include here. We'll touch on all this later.
How can you adjust your budget for financial goals?
Sometimes, when you look at your budget, there's simply not 20% of your pre-tax income available after bills and other expenses to put toward financial goals. That's OK. You can work toward this — here's how.
Start saving what you can
When you go through your budget, you may only have a small percent of your salary left to save, and that’s better than nothing. You can open a high-yield savings account (HYSA) and begin transferring your surplus into it.
This will allow you to take advantage of compounding interest right away. The sooner you take advantage of it, the more interest you'll earn.
Trim your budget where possible
For example, if you have a streaming television service but rarely watch TV, you may be able to eliminate it. Also, if you have an unlimited cell phone plan and only use a few gigabytes of data per month, you may be able to cut back to a limited plan and save.
Wherever you can find these small savings by trimming your discretionary spending — spending that isn't necessary to live — you can then apply this newfound extra money to your monthly savings.
Increase your income
With every raise or bonus you get from work, try to maintain your living expenses and apply a large portion of the extra income to your savings target. This can increase the percentage of your monthly income you're saving without impacting your standard of living.
You can also take on a side gig, such as being a rideshare driver, delivering food or freelancing, and applying extra cash to your savings. Then, once the income from your full-time job is sufficient to cover the 20% savings, you can scale back the side gig.
How can you save toward financial goals while managing debt?
That 20% mentioned earlier that goes toward financial goals includes paying off debt, but it’s all about prioritizing. For example, paying off debt may not be an immediate priority if you have a $2,000 credit card balance on a 0% promotional APR card for the next 18 months. You still want to pay it off before the interest starts accruing, but you have 18 months to do that.
In this case, you may earn more in interest by simply making the minimum payment and putting your extra money in a savings account. Then, when the promotion is expiring, pay off the balance with a portion of your savings.
Now, if you have interest-bearing credit card debts and loans, you should look at your goals and adjust as needed. For example, if you haven't built an emergency fund covering three to six months' expenses, it may be best to divide the 20% for financial goals between saving and paying off debt. You can divide it in whatever way is most comfortable for you, so long as you're making progress on both.
Suppose you have an emergency fund stashed away in a bank account that'll cover three to six months' worth of expenses. In that case, you can focus the full 20% on paying off debt first, as the high interest rates charged on credit card debt will almost always cost more than you can earn in interest from saving.
Once you eliminate debt payments, you’ll have even more money available to apply toward your savings, helping you catch up on the lost time.
How does retirement savings fit into all this?
A key personal finance goal for many Americans is retirement, as it presents the opportunity to slow down and do what you want to do. For some, that's early retirement using the FIRE method, while others are comfortable with the more traditional 62- to 65-year-old retirement age.
Regardless, part of your financial planning should include retirement savings. And this is a financial goal, so you should fit it in with the 20% you're saving. You could go with a 15/5 split. So:
15% — including any employer match — would go toward saving for retirement, like into an individual retirement account (IRA), 401(k) or brokerage account
5% would go toward short-term savings plans, like a down payment on a car or buying that new television you want
How to fit the 20% financial rule of thumb into your budget
When it comes to saving money, what is a good rule of thumb? As we’ve established, 20% of your pre-tax income is ideal. However, applying 20% of your pre-tax income toward financial goals, like saving money, can be tough with your tight budget, debts or other long-term goals.
Fortunately, you can slowly modify your budget to creep toward the 20% mark, work your debt into the plans and even fit in retirement savings.
If debt is standing in your way, free up even more money to save with the Tally† credit card debt repayment app. The app helps you manage your credit card payments and offers a lower-interest personal line of credit, allowing you to efficiently pay off higher-interest credit cards.
†To get the benefits of a Tally line of credit, you must qualify for and accept a Tally line of credit. The APR (which is the same as your interest rate) will be between 7.90% and 29.99% per year and will be based on your credit history. The APR will vary with the market based on the Prime Rate. Annual fees range from $0 to $300.