A painless way to dramatically increase your rate of saving is to save a percentage of all increases in income. It’s painless because you have not had that income to spend, so increasing your rate of saving this way does not adversely affect your standard of living. There is no need to sacrifice. In fact, if you save only a percentage of your increases in income, you can still use the remainder to advance your standard of living. You enjoy the best of both worlds: an increased rate of saving and a boost to your standard of living.
Most increases in income occur in your 20’s and 30’s
Recent studies show that the most advantageous time to employ this strategy is in your 20’s and 30’s. It is during these two decades that the highest increases in inflation adjusted income occur. In a labor department study that followed 10,000 workers’ earnings from 1979 to 2012, those that had college degrees averaged +9% per year increases in inflation adjusted income from ages 18-24, +6% average per year increases from 24-29, just under 5% average per year increases from 30-34, just under 4% average increases from 35-39. By your 40’s you can expect increases in income to taper off dramatically. The study showed a drop in the average annual increase in inflation adjusted income to just over 1% from ages 40-48. Inflation adjusted income plateaus in your 50’s and may even decrease as you approach retirement age in your 60’s.
By capturing a portion of these average annual increases in income during your 20’s and 30’s to realize a progressively higher rate of saving, you accomplish two complementary objectives: 1. you save more relative to your income which makes it easier to achieve financial independence, and 2. you keep a lid on your standard of living relative to your income which also makes it easier to achieve financial independence. By increasing your rate of saving substantially in your 20’s and 30’s, you also take advantage of time to compound the earnings on your savings.
I experienced these benefits firsthand. In my case, I didn’t save anything until very late in my 20’s. I spent the early years digging a hole of debt. Fortunately, credit was not as plentiful then, and I didn’t earn that much, so my debt in dollars and cents wasn’t that much by today’s standards, but relative to my income, it was huge. Then at age 28, my income more than doubled overnight. All of that extra money frightened me into creating a budget so I didn’t blow it all. And with the budget came savings. I don’t recall how much of the increase I saved, but it was somewhere in the vicinity of 20% to 30%. The rest went to pay off debt. Thereafter, I saved most of my pay increases and bonuses. In fact, Rosa and I saved a high percentage of both of our salaries by of socking away pay increases in our late 20’s and throughout our 30’s; we basically lived on the equivalent of one income, even though both of us worked full time at professional jobs.
Pain awaits those who put off serious saving until age 40 or later
Unfortunately, most in their 20’s and 30’s employ increases in income exclusively to boost their standard of living, thinking they have time to plow money into savings beginning in their 40’s. Not only have they lost 15 to 20 years of compounding, their increased standard of living makes it nearly impossible to save enough money to attain financial independence, even at retirement age. To make matters worse, by their early 40’s the era of large percentage increases in inflation adjusted income have probably passed them by. This leaves them with the unhappy and difficult task of downsizing their standard of living in order to save at a high enough rate to achieve financial independence. Because it is painful to cut back on spending once one has become accustomed to a certain standard of living, most will be in denial of the need to downsize until reality hits in their mid-50’s, making the likelihood of setting aside sufficient savings to achieve financial independence a near impossibility.
The situation is made worse for those who choose to use increases in income during their 20’s and 30’s exclusively to improve their standard of living if they postpone starting a family until their late 30’s or early 40’s They haven’t had the expense of child rearing early in adulthood to temper their spending. With their standard of living firmly established, the cost of raising children only adds to their spending at a time when those who had children early in their working years are shedding that expense and adding to savings. It is improbable that those who begin families in their late 30’s or early 40’s will reduce their standard of living during this time as they will want to give their children every advantage possible. Downsizing for them won’t begin until their late 50’s or early 60’s, far too late to set aside sufficient savings with which to enjoy financial independence.
Rather than increase our standard of living based on increases in income, Rosa and I have increased our standard of living based on our accumulated savings: Can our accumulated savings sustain an increase in our standard of living? That has always been the test.
Studies of historical data may not reflect your reality
According to the recent historical data, the time to take advantage of pay raises to boost your rate of saving is in your 20’s and 30’s. The steady stream of high percentage increases in income during that time establishes, by age 40, your level of income for the rest of your working life. If you wait until your 40’s to get serious about saving, you will have missed the bus. But there is another reason to take advantage of pay increases early to boost your rate of saving: you may not experience that steady upswing in income during your 20’s and 30’s; your income may go up and down throughout your working life.
That has been our experience. Rosa and I each had career changes that set our joint income back, once in our 30’s and once in our 40’s. Our joint income declined again in our late 40’s when Rosa took a year off and then worked part time as a substitute teacher for several years afterward in order to be a caregiver for her mother. She then worked full time for several years as a paraprofessional, making a fourth of what she would have earned as a teacher. The last three years of her working career, Rosa returned to full-time teaching which sent her income skyrocketing. However, at that time, income from my business had declined. When we had those declines in joint income, we saved less; when our joint income recovered, we saved the increase.
Despite the studies, you don’t really know how your income will grow throughout your working life, so it is only prudent to take advantage of any and all pay increases, whenever they occur, to boost your rate of saving.
K. C. Knouse is the author of True Prosperity: Your Guide to a Cash-Based Lifestyle, Double-Dome Publications, 224 pages