How much to set aside for your future
By Randell Tiongson on May 20th, 2012Question: How much of my income should I save? How much of my savings should I allocate for retirement, education, emergency funds and other future costs?—Allan Magtoto, corporate employee via e-mail
Answer: There are no hard and fast rules when it comes to these things. Personal finance is very personal and concerns like these are relative and subjective. Ratios and formulas are broad gauges and theoretical in nature. A more thorough personal analysis is the best approach to answering your queries and a professional financial planner is the best person to answer your query. It will be in your best interest if you see one.
I can give you some suggestions that may provide some broad stroke answers to your questions.
In my talks and seminars, I often talk about the 70-30 rule at great lengths. It means that for every 100 percent of your net income, you limit your spending to 70 percent and save and invest the remaining 30 percent. In the past, we have heard about saving 10 percent of your income and you will be OK. I’ve done the math and 10 percent will simply not cut it. Considering inflation, accumulating just 10 percent of your income will not be enough for the many life events that you will need to prepare for financially. However, 10 percent is indeed a good start especially for those who are having a difficulty setting aside money on a regular basis. As you get a better handle on your finances and as your income goes up over time, increase the percentage allocated for your savings and investments until it reaches the ideal rate of 30 percent. For the younger ones with no dependents yet, a higher percentage of savings will be a great idea and will allow them to get a much-needed head start in an uncertain future. The 30-percent savings can be used for the many events that we need to plan for.
For emergency funds, allocating three to six months’ worth of your expenses would be a great hedge against whatever emergencies you may have to deal with, including sickness or loss of employment. Many of us do not have emergency funds, which is unwise. I recommend you start with building your emergency funds first before tackling the other concerns. Once you have done this, then you are ready to start preparing for your other life events.
As to education, it is best if you can compute estimates of the escalation of tuition costs and match those with appropriate investment planning, which a professional financial planner should be able to help you with. Again, and for the interest of this column, I would give you a ratio that can be a good broad rule: allocate 10 percent of your income for future educational needs of your children. Savings for education should be invested properly so that the growth of the funds will overtake the rising cost of education. You may want to do regular investing for the next 10 to 15 years of the child, which should be able to cover future education costs. Pooled funds like UITF or mutual funds might be a good choice as an investment instrument, among others. If the funds exceed the actual educational costs of your children, you may want to divert the excess to other needs like retirement funding.
For retirement, 10 percent of your income is also a good theoretical ratio. Retirement, like most things in life is relative. If you plan to have a very comfortable and luxurious retirement, then it will take you more than just 10 percent of your income. However, a decent retirement should be able to be achieved with regular retirement investing for at least 20 years. Retirement is a long-term need so it is best financed by long-term investments like real estate, stocks, mutual funds, UITF and business ventures. The longer you prepare for retirement, the better it will be for you to grow your capital. Long-term investments will allow you to wait out the volatility of the investment environment. As a general rule, investments, though fluctuating, should go up over time.
Another 10 percent of your income can be for a general savings fund, which you can use for other plans like equity for your home, family vacations, seed for business capital. Just make sure that you invest your savings properly and you understand the relationship of risks and returns.
Let me reiterate that what I wrote here are merely broad stroke allocations and should only be followed as a general rule. We all have individual needs and preferences; therefore, we should have individual planning. Certain financial requirements may take precedence over others—a home might be a priority over retirement during the earlier periods of your life.
This column appeared at the Philippine Daily Inquirer.
Hi Randell,
I’m confused. So following your article, 70/30 rule says 30% should be invested. So yung 30% of my net income should be divided to “other life events”. By other life events, are you referring to what you have identified such as: emergency funds, education funds, retirement funds, investment funds? Ergo, yung 30% ko dapat spread out sa four items na ito? eh di maliit? If divided equally, 7.5% of my net income goes to each one. Tama ba ang aking understanding?
For your guidance. Thanks
I think dividing 30% to four different parts would be better instead of 10% being divided into four parts. I think what Sir Randell is saying, instead of saving just 10% is not enough, since there are a lot of things that we need to build funds for. Just my 2 cents po.
Hi James Galang,
As a financial advisor myself, let me try to clarify what Mr. Tiongson is talking about.
First, as we can see Randell mention, we should try to set up our emergency funds before anything else. This helps us be better prepared for unfortunate events such as job termination or needs in medical expenses.
To Quote Randell,
“I recommend you start with building your emergency funds first before tackling the other concerns. Once you have done this, then you are ready to start preparing for your other life events.”
So this means that before any preparation for future life events such as education of our children, retirement, etc, let’s first try to get these emergency funds ready, in which case a fund amounting to 3-6 months worth of expenses would be a good, emergency fund.
Once we have covered our emergency funds, then we can move on to preparing for other significant life events. This is where the “70/30” general rule comes in, wherein 30 percent of your income should be set aside for savings and investments.
Remember, a wise and responsible earner uses the following formula in his flow of money:
INCOME – SAVINGS = EXPENSES
So given that we’ve set aside 30% from our income, we then can see how we’ll allocate this 30%.
Let me quote Randell from three different paragraphs in this article:
EDUCATION
“Again, and for the interest of this column, I would give you a ratio that can be a good broad rule: allocate 10 percent of your income for future educational needs of your children.”
RETIREMENT
“For retirement, 10 percent of your income is also a good theoretical ratio.”
SAVINGS
“Another 10 percent of your income can be for a general savings fund, which you can use for other plans like equity for your home, family vacations, seed for business capital.”
When we add these three regular allocations or setting aside from our income, we get a total of 30%.
It is important to note that our emergency funds are not set aside in the same manner as our preparation for EDUCATION, RETIREMENT, and SAVINGS.
Our emergency funds are there for one sole purpose, an EMERGENCY. This means that once we’ve set it up (prior to setting up our education, retirement, and savings fund), we will no longer touch our emergency fund unless we are in need that can be classified as an EMERGENCY. This means that we would do our best efforts and put in our best discipline to NOT TAKE MONEY FROM OUR EMERGENCY FUNDS for whatever purpose aside from an emergency.
This then also means that since the emergency fund is just there sitting, not being touched, we also do not need to add to it unless we had to previously use it for an emergency. In this case then we again would have to build up our emergency fund until it reaches an amount of 3-6 months worth of expenses.
Our EDUCATION, RETIREMENT, and SAVINGS work differently in a way that we REGULARLY invest money for these funds. One reason for this is because most, if not all, of these funds require a much much greater amount than that of our emergency funds. So regularly investing for these funds could help us become better prepared when we need it.
This is where our regular setting aside of 30% from our income goes into.
There is much more to know and discover regarding savings and investment, but I hope this helps you get a better idea of what Randell was trying to say.
30% is, as Randell says, a good place to start as to get an idea of how much we need to set aside from our income. However, I would agree with Randell in saying that one thing’s for sure: savings and investment must be tailor-fit to each individual. We all have different needs and goals, which is why the exact amount needed to save and invest would never be the same for any two persons.
If you’re interested to know more, let me know 🙂
Regards,
Jotham