We recently had a conversation with another couple. During the discussion they mentioned that they only contributed enough to their 401k accounts to get their employer match. They maintain that they do not earn enough to max out their 401k contributions. Now that sounds like a fairly typical argument; however, from past conversations we learned this couple has an annual income over $250,000 per year! How crazy is that!
Maxing out 401k contributions would amount to less than 15% of this couple’s income. This conversation really underscored the point: Most of Us Do Not Live Below Our Means
While they could be saving in other areas, a savings shortfall for this high earning couple is quite common. According to the Federal Reserve Bank of St. Louis the average Personal Savings Rate in November 2018 is 6%. So, it’s no wonder this couple thinks they don’t earn enough to max out their 401k accounts. At a 6% savings rate, they would need to earn $616,666 annually to contribute the maximum per couple of $38,000!
The scariest part is that 6% is an average, meaning that it takes into account those with significant savings rates. As such, the median savings rate is likely much less than 6%. As an example, Magnify Money, sifted through Federal Reserve data for savings account and retirement account balances and had a couple alarming takeaways:
The median American household currently holds about $11,700 across these same types of accounts.
29% of households have less than $1,000 in savings.
How Much Does the Average American Have in Savings? – Magnify Money
In looking at findings like these, it is clear that the majority of folks are living at, or beyond their means. However, I suspect most don’t realize it. Perhaps, people don’t really have a grasp of what living below your means actually means?
I know that we didn’t. We spent several years inflating our lifestyle without much in the way of savings. You can read more about Our Money Missteps here. There was a period of time when we looked to coworkers, friends and family as a basis for our lifestyle.
Let’s be clear: Living Below Your Means is not a function of your job, your seniority, your social status, or the standard of living that your neighbors and close friends demonstrate.
Comparing your lifestyle with your peers is an iffy proposition at best. Those around you may be living so far beyond their means that your “reduced” lifestyle still stretches beyond your means.
What are Signs of Living Beyond your Means?
- Running out of cash before the next paycheck
- Putting off needed home or auto maintenance because of costs
- Avoiding routine health checkups and exams due to cost concerns
- Not paying off your credit card balance, in full, every month
- A low credit score
- Making minimum payments on student loans
- Low to no emergency fund savings
What are Signs of Living At your Means?
- Not contributing to your 401k (or similar tax-deferred) savings buckets.
- Multiple monthly payments on consumer goods (TVs, mattresses, furniture)
- It takes 2 earners to pay the mortgage
- Your definition of “affording” something is that you can make the monthly payment… not that you can buy it outright.
What Does Living Below your Means Look Like?
- A healthy emergency fund balance (typically 3 to 6 months of spending)
- Contributing fully to tax deferred savings buckets such as a 401k
- The ability to handle routine home and auto maintenance without going into debt
- Keeping up with health checkups and exams
- The ability to take advantage of investing opportunities when they arise
- The ability to donate to causes that matter to you
- Staying on track to meet your retirement goals
Numerically Speaking are You Living Below or Beyond Your Means?
If you are not saving anything, or if you have no emergency savings built up, then you are living beyond your means. The slightest misfortune, such as car trouble, job loss, or a medical bills, will drive you into debt from which you cannot easily recover.
If you have an emergency fund and are putting away some savings, then the answer isn’t so straight forward. In fact, its very much a personal calculation. Whether you are living below or beyond your means comes down to whether your savings rate is high enough to meet your goals.
First Determine Your Savings Rate
Add up your income sources. This includes your W2 income (aka your day job) and any side hustle income. This should be your “take home” or net pay, since your take home pay is what your are living off of. This is what you are left with after deductions for taxes, healthcare, social security, 401k (or similar) contributions, and Health Savings Accounts (HSAs).
Add up your savings for the year. This includes retirement contributions, deposits into savings or brokerage accounts. This will require a bit of study of bank account and credit card statements. However, if you use personal finance software, such as Personal Capital (my favorite), this review can be completed in minutes. If you aren’t saving anything, then unfortunately, this calculation is even easier.
Divide your annual savings by your annual income. This is your savings rate.
The Heartland on FIRE Savings Rate
Using our household as an example: We have a take home pay of $4,207 per pay period. With 26 pay periods per year, that is $109,382 annually. Between our 401k contributions and HSA savings we save roughly $1,600 per pay period, or $41,700 on an annual basis. Dividing our savings of $41,700, by our take home pay of $109,382 yields a savings rate of 38%.
This is the value I focus on since it is within our control. However, we are fortunate that our savings is bolstered by some perks from our employers. When you factor in approximately $11,300 in company match for our 401k accounts and $2,200 for employer HSA contributions, this rate swells to 50.7%.
Compare Your Savings Rate to Your Financial Goals
What’s your rate? What should it be? There are differing benchmarks out there. Conventional Wisdom (what I call Old Thinking) is that you should have a savings rate between 10% to 15%. On the other hand, many in the Financial Independence| Retire Early (FIRE) community have savings rates higher than 50%!
One thing is clear, your savings rate sets the tone for your path to retirement. (FYI, I use retirement and Financial Independence interchangeably). It’s hard to say it much better than Mr. Money Mustache did in his post, “The Shockingly Simple Math Behind Early Retirement” So I won’t attempt to do so here. In particular, one table from this post really stands out to me:
This chart makes a couple assumptions, which are important to note:
You can earn 5% investment returns after inflation during your saving years
You’ll live off of the “4% safe withdrawal rate” after retirement, with some flexibility in your spending during recessions.
Source: The Shockingly Simple Math Behind Early Retirement – Mr. Money Mustache
An interesting take away is that a savings rate of 10-15% has a corresponding working career of 51 and 43 years, respectively! For someone getting out of college at an age of 22 that means working to the ripe old ages of 73 and 65! So, if a conventional “work til 65+ then retire” path is fine for you, then shoot for an average savings rate of 10-15%. However, if you already have years of savings below this target rate, you would need to increase your future savings rate to counter these below average years.
If you are like me and want to reach Financial Independence (FI) as soon as possible or if you got a late start on savings, then you need to set your sights much higher. Running your specific numbers through any of the multiple retirement calculators can give you an idea of whether you are on track or not. (I prefer Firecalc and Personal Capital’s,in addition to the down and dirty one I developed which you can find HERE.
Our goal is to retire within 15 years which would have us reach FI just before the age of 50. Our savings rate of 50.7% (including employer contributions) has us very close to our target. However, our stretch goal is to reach FI earlier, around 45 or so. So, in that regard, we are still living a bit beyond our means.
Run the numbers yourself. Are you living below your means or beyond them?
Living Beyond Your Means? Now What?
Many will find they are, in fact living beyond their means. Don’t beat yourself up too much. After all, most of your friends and family are in the same position. But now is the time to reverse course. How can you turn it around?
The first step is to get a handle on where your money is going. The major expenses are your house, vehicle and food. For families, daycare can rank up there as well.
Once you know where the money is going, start reviewing at each line item. Think about how you can reduce or eliminate them. Some ways to save are relatively easy.
- I previously posted about 10 Lazy Ways to Increase Your Savings Rate.
- Grocery shop at Aldi, Sam’s or Costco.
- Use meal planning to reduce grocery costs and cut back on costs for dining out.
Some are not so easy:
If your housing costs are too high, you will struggle greatly to achieve a high savings rate. Consider downsizing your house or rental, or perhaps relocating to a lower cost of living area. Larger homes often come with higher maintenance costs and property taxes, so downsizing can help more than just your mortgage payment. If possible, try to move as close as possible to your work, to minimize transportation costs.
Think long and hard about buying a new car. If you do need to buy another vehicle, focus on reliability and efficiency (both fuel and function). If you have a full-size pickup (as I once did), it’s worth considering trading down to a smaller vehicle. That’s what I did in 2018.
You can buckle down at work to try to earn a raise. Alternately, you can start a side hustle to earn some additional income.
In Summary
It is important to know what your “means” really are. Whether you are living below, or beyond them depends on how your savings rate compares to your target rate. Regardless of the outcome of the math, you can take action now to start moving the results from “Beyond” to “Below”.
Thanks for reading!
When you add in 401k match and HSD contributions from the employer, you have to count those as both savings and income when calculating savings rate. All the savings rate/time-to-retire calculations rely on the assumption that savings + spending = income. If you treat those contributions as savings but not income, that would imply a reduction in spending which isn’t real. The $13,500 in savings paid by your employer brings your modified savings rate to 44.9%, not 50.7% as stated.