When it comes to most areas of personal finances, thinking in terms of percentages instead of whole dollars is usually the right mindset.
When we save, we should have a percent, not a dollar in mind.
When we invest, we should have a percent, not a dollar in mind.
And when we spend, we should have a percent, not a dollar in mind.
Why should we use percentages in our financial lives? It’s because our lives change, and percentages are designed to adapt to those changes.
Whole dollars won’t account for the changes in your life. If you get a promotion and are saving and investing the same based on a whole dollar philosophy, then you’re losing out on the opportunity to save and invest the incremental difference.
As soon as I got a raise, the first thing I did was go into my retirement account and determine how much more I could contribute per paycheck to offset the additional paycheck amount.
Many people have various recommended amounts that they claim we should save each month. The bare minimum is said to be 10% of your paycheck. I don’t see too much of that written anymore. Instead, it’s changed to 20%. But it’s still based on a percentage rather than a dollar.
Yes, it’s true that the maximum amount you can contribute to a 401k is $18,500 and an IRA is $5,500. It’s a whole dollar amount that’s set by the IRS. And if you can do that, it’s truly awesome!
Long-Term Result Proven
Over the long-term, the saving using percentage is the clear winner. Suppose you start off with a salary of $50,000 per year. And each year your salary goes up by 3%. Check out the chart below with the comparison of saving the same $10,000 per year versus or 20% of income per year. It’s the same amount in year one, but increases each of the following years due to the fact that salary is increasing each year:
|Year||Income||Dollar Savings||% Savings|
|1||$ 50,000.00||$ 10,000.00||$ 10,000.00|
|2||$ 51,500.00||$ 10,000.00||$ 10,300.00|
|3||$ 53,045.00||$ 10,000.00||$ 10,609.00|
|4||$ 54,636.35||$ 10,000.00||$ 10,927.27|
|5||$ 56,275.44||$ 10,000.00||$ 11,255.09|
|6||$ 57,963.70||$ 10,000.00||$ 11,592.74|
|7||$ 59,702.61||$ 10,000.00||$ 11,940.52|
|8||$ 61,493.69||$ 10,000.00||$ 12,298.74|
|9||$ 63,338.50||$ 10,000.00||$ 12,667.70|
|10||$ 65,238.66||$ 10,000.00||$ 13,047.73|
|$ 100,000.00||$ 114,638.79|
As you can see, the percent method will provide almost $15,000 more in savings at the end of 10 years.
What does this mean if you invest your savings each year? Assuming we use a 7% return, the percentage method is super-charged to perform better!
|Dollars at 7%||Return||Percentage at 7%||Return|
|$ 700.00||$ 10,700.00||$ 700.00||$ 10,700.00|
|$ 700.00||$ 21,449.00||$ 721.00||$ 21,749.00|
|$ 700.00||$ 32,950.43||$ 742.63||$ 33,880.43|
|$ 700.00||$ 45,256.96||$ 764.91||$ 47,179.33|
|$ 700.00||$ 58,424.95||$ 787.86||$ 61,736.97|
|$ 700.00||$ 72,514.69||$ 811.49||$ 77,651.30|
|$ 700.00||$ 87,590.72||$ 835.84||$ 95,027.41|
|$ 700.00||$ 103,722.07||$ 860.91||$ 113,978.07|
|$ 700.00||$ 120,982.62||$ 886.74||$ 134,624.24|
|$ 700.00||$ 139,451.40||$ 913.34||$ 157,095.67|
|$ 7,000.00||$ 693,042.84||$ 8,024.72||$ 753,622.42|
This is where it really makes all the difference. Again, assuming we use a 7% rate of return, you can earn almost $61,000 more if you use the percentage savings method and invest the funds you’ve save in the stock market.
Dollar Method Can Tempt You To Overspend
When you’re saving the same dollars month after month, year after year, an excess can build up, or NOT if you’re not careful.
Since you’re incoming is accumulating and you’re savings amount is staying the same, you may be tempted to overspend on things.
And in spending that excess build up, you may miss out on investment opportunities or chances to increase existing investments like your 401k or IRA accounts.
Streamline Expense Budgeting With Percentages Too
Instead of figuring out where every single dollar should go, make your life easier and assign percentages to each expense category. For example, try to keep your mortgage payment expense below 28% of your income.
You can also follow the simple 50/30/20 budget rule. This rule breaks down your budget as follows:
50% – necessities – mortgage, utilities, car payment
20% – for your future – savings, investing, retirement
30% – discretionary – dining, vacation, entertainment
As your financial situation improves (through pay increases and/or debt payoff) and you get the hang of budgeting, you can play around with these numbers. This may result in, for example, 45% in necessities, 30% in future, and 25% in discretionary.
My free budget template can help get you started!
Keeping your finances simple is a recipe for success. And establishing a percent savings and investing system provides automation and allows the numbers to do the work while you sit back and watch.
Join The Discussion:
- Do you save and invest using a percentage philosophy?
- How often do your savings and investing percentages change?
- Do you for your budget your expenses on a dollar or percentage basis?
I use Personal Capital because (1) it’s free, (2) it tracks all of my accounts and overall net worth, (3) my account balances automatically update, (4) it shows how my investments are diversified and allocated in various sectors, and (5) can use built-in tools like “Investment Checkup” to get….wait for it…free personalized advice!
Check out my simple, yet detailed Personal Capital Review here.