What percentage of my salary should I invest each month -10%,20%? This is a common question in personal finance forums and now in Quora. There are several wrong questions that people ask when it comes to personal finance and this is one of them.
There is something weirdly comforting about a thumb rule. The answer to this question often is, "as a thumb rule, one should save 10% each month". Every equation has underlying assumptions buried deep within. A thumb rule has twice the number of such assumptions because it is often the simplification of a formula.
Most of do not stop to think, 'when does this thumb rule apply, or more importantly, 'when does it not apply'.
But first, what is the reason behind this question: "how much should I invest?". My bet is on guilt-free spending.
A young earner is often looking for some older jobless guy to cough out a nice looking percentage - 10%, 20%. Then, that 'thumb rule' can be applied and the rest can be spent guilt free.
Now where does this 10% or 20% come from? In this day and age, the difference between applying a thumb rule and using a calculator (app, if you will) to get a more exact answer is about 5 minutes.
The 10%/20% is the result of a retirement calculator with assumption of 2-3% inflation, social security, average increase in income etc. CNN Money has one such calculator applicable for US residents. Even with
Here is a screenshot with following fine print
- longevity up to age 92
- Social Security is factored in.
- All calculations are pre-tax
- calculated using an inflation rate of 2.3%
- return is 6%
- inflation-indexed annuity rate is 6%
- current income grows at an annual rate of 3.8%
- assume you can live comfortably off of 85% of your pre-retirement income
Notice that the savings rate should be 23% for a real return of close to 4% (return =6%, inflation is 2.3%) with social security available and tax has not been factored in!!
It is folly to assume even for US conditions that investing 10% or 20% of income is sufficient. Our inflation is anywhere between 8-10% (assuming no lifestyle change expenses -good or bad).
Our portfolio returns (not just equity) will have to be at least 10-12% after tax to combat inflation.
Want an (unpleasant) Indian thumb rule? Invest as much as you spend each month for normal retirement when you unmarried with no dependents. At least, try to invest 50% of what you spend later on.
For early retirement in India, invest close to twice as much as you spend each month. Not impossible, but depends on your priorities (an understanding spouse and of course, luck*). I have managed to do this for the last 8 years or so and am within striking distance of financial independence:
* Blessed with an understanding spouse, but not with luck when it comes to unexpected recurring expenses
Wait a minute. Did I not just say thumb rules 'suck'? Use this simple calculator to find out what percentage of your expenses (not income) you should be investing for retirement. Will only take you about 5 minutes. Here is a screenshot with inputs that I would use.
The post-retirement rate of interest is 1% above inflation rate. For normal retirement, this is borderline reasonable and therefore, borderline dangerous. Recognise that is for 30 years later!! Who knows what will happen then! Better to be reasonable, err on the side of caution to start with, use the retirement calculator once a year with updated inputs. As retirement approaches, the numbers will become more accurate.
There are too many assumptions involved and while we can be reasonable with our inputs, the only security is to invest more, as early as possible. Another reason to do so is because as we age, unexpected expenses may increase. For example, we may need to take care of our parents.
Download the retirement calculator as a function of monthly expenses
Non-windows office users can upload this Google drive. This will also work as-is on Mac Numbers and Mac Excel.
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