Should Higher Earners have Higher or Lower Saving Rates?

March 30, 2019 — Leave a comment

Quiz!

Say that you earn $100k/year, and you save $10k/year, or 10% of your income. You got a big promotion, and your income jumped to $160k/year. What should your new saving rate be? Please select the best answer.

  1. Increase your savings nicely to $13k/year (but lower your saving rate to 13k/160k = 8%).
  2. Keep your saving rate at 10%, increasing your savings to $16k/year.
  3. Increase you saving rate to 20%, increasing your savings to $32k/year.

Should Higher Earners have Higher or Lower Saving Rates?

Say that you earn $100k/year, and you save $10k/year, or 10% of your income. You got a big promotion, and your income jumped to $160k/year. Should you keep your saving rate of 10%, increasing your savings to $16k/year? Should you increase your savings by less than that or even more? For many reasons, you should increase your saving rate, leading to new savings greater than $16k/year. Here are a few reasons:

  1. Usually, the higher your income, the lower your job security. Many more people compete for CEO or VP roles, than a fast food restaurant employee. You need to build security through savings faster to make up for your declining job security.
  2. If you lose your job, there are fewer jobs to choose from, the higher the income.
  3. The excess happiness obtained by increased spending goes down quickly as the amount goes up. Reducing financial stress typically brings much greater happiness.
  4. Social security covers a smaller portion of high incomes. If you earn $30,000 per year, social security will give you a retirement greater than half of your earnings. But, at $300,000 per year, social security income covers a small portion of the income you got used to. It is up to you to make up the difference. To get income of $300,000 from a portfolio that can generate 3% per year, you would need to build savings of $10,000,000. If you want to enjoy anywhere near the standard of living you got used to, you need a very high saving rate combined with investing for high growth compounded over many years.

The good news is that even at 20% = $32k saving rate, your income available to spending grows by a substantial: (160k – 32k) – (100k – 10k) = 38k minus income taxes. You get the double benefit of higher spending along with a big increase in your saving rate.

Quiz Answer:

Say that you earn $100k/year, and you save $10k/year, or 10% of your income. You got a big promotion, and your income jumped to $160k/year. What should your new saving rate be? Please select the best answer.

  1. Increase your saving nicely to $13k/year (but lower your saving rate to 13k/160k = 8%).
  2. Keep your saving rate at 10%, increasing your savings to $16k/year.
  3. Increase you saving rate to 20%, increasing your savings to $32k/year. [The Correct Answer]

Explanations: Read this months’ article for an explanation.

Disclosures Including Backtested Performance Data

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Gil Hanoch

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