At a recent dinner with a friend, we were talking about my blog when my friend asked me a pretty simple question;
I’ve always had the view that savings and investments are a good way to protect myself from the uncertainties of life. Given that you lost your parents early on, how do you view savings and more importantly, how much do you think I should be saving given that I’m only in my 20s and at the start of my career?
Despite having made many financial mistakes over the years (and presumably with a few more yet to come!), I’ve always viewed the decision to save and invest in my early 20s to be one of my best financial decisions. At age 20, I’d decided to set up a direct debit scheme with Zopa Loans to try and beat poor returns on savings accounts with the high street banks. At 21, I’d decided to squirrel money away into a pension to prepare for old age. At age 22, I’d started measuring things like my monthly savings rate, expenses breakdown and by 23 was investing in the stock market through a stocks and shares ISA as well. Thanks to a gradually increasing monthly savings rate, multiple asset classes and a focus on asset performance, I’ve now got a reasonably robust financial safety net.
By making a conscious focus to save and invest, I’ve created stability which allows me to sleep well at night and focus on things other than money (i.e the really important things like health, friends and family). The lack of stress around how to pay rent or the risk of losing my job actually allows me to outperform; instead of living in a world of fear, I can concentrate on how to exceed expectations and seek out opportunities to help those around me instead of constantly watching my back and looking inward. In short; I became a different (and in my opinion) better person because I wasn’t being held hostage by my finances.
Now that I’m creeping towards the middle of my 20s, I’ve started thinking about how the next part of this decade could turn out. I don’t pretend to know all the answers, but my friend’s question gave me a prompt to try and share my answer to how much you should save in your 20s.
So how much should you save in your 20s?
It’s a question which can confound the best of us. When my Father died in 2008 and I asked myself how much I thought was prudent I was at a bit of a loss. I knew that I definitely should be saving cash, but I had no idea how much was a sensible amount. Were other people my age doing the same thing? Did they intend to start later in life? Was it even necessary to think about things like this? Having some sort of guidance would have been useful; at least I would have known I was on the right path.
I started asking around; everyone had an opinion. Some people said 10%, which seemed too low to me – others said as high as 50%, which seemed impossible! I used to wonder “Where are these numbers coming from? Who could possibly afford to save so much of their paycheque? They must be millionaires! In which case, why are they saving at all?” I was utterly confused by what seemed to be a totally random number.
As there wasn’t an obvious answer, I decided to follow a process which I’ve continued in later life; use some common sense, make a decision and then trust in it. I knew that if I wanted a financial safety net I needed to save something. My parents dying young had taught me to seize the initiative; I might not get the chance tomorrow. In short, I decided;
Save as much money as you can in your 20s (and at any other time!)
Regardless of how much I was earning, I decided that I needed to save as much as I could; until I was really noticing it leaving my bank account every month. If I had £500 left over at the end of the month after expenses, I’d save as much as I possibly could – I’d deliberately say ‘NO’ to spending over saving unless it was something I really needed. Sometimes, that might mean I had to turn down offers to go to the pub, and it might mean not getting a car when all my friends were desperate to start driving; but if I had a cheaper alternative, I’d save money and put it towards my future. When I started out; this was barely £50 a month, but as I’ve increased my income, this has grown by multiples.
As a rough rule of thumb, I aim for my housing costs (rent and bills excluding food and travel) to consume around a third of my income, and for savings to consume around another third. Some months it’s more, some months it’s less – but year on year, I try to save at least a third of my income. Any gift cash I get, I try to save (not always, as sometimes we deserve a treat!). Any spare change, I try to save. I take part in savings challenges; for example, for 2017, I save 1p on the 1st day of the year, 2p on the 2nd day of the year, 3p on the 3rd day of the year, all the way up to £3.65 on the last day of the year. I contribute to two pensions and have several standing orders transferring funds to other accounts as soon as my paycheque arrives each month. All in all, this means that although I notice the money going out of my account, it\’s gone before I have a chance to spend it!
Of course, saving is only one part of my plan. Alongside this, I also decided to explore option for getting my money working for me.
Buy assets that generate a monthly income
What you do with your money is important. It’s no good saving money one month to spend it the next (except in limited circumstances). If you did this, you’d end up with lots of ‘stuff’ you’ve saved up for, and no actual savings to provide a financial safety net. Alongside this, recognise that cash savings are just a tool; their use is limited if they’re just left in a bank account. The secret to financial security is getting your money working work for you by purchasing assets with a positive net cash flow – otherwise known as investing!
Rather than buying assets that only profit through a capital gain (gold, for example), I decided to concentrate on income-generating investments which paid out cash on a regular basis. My ultimate goal was to build a portfolio which generated enough cash to offset some (if not the majority) of my expenses, creating what some financial bloggers call ‘financial freedom’.
When I started, I was barely able to generate more than a few pounds a year – not even enough to cover a single month’s phone bill, let alone anything more significant! But by focusing on reinvesting that money, rather than just spending it, my income has compounded over time into something more significant. Thanks to starting early, my life is on a significantly different course to many people my age. Where many people think of saving and investments as something for ‘later’, I decided to dive in headfirst and am therefore reaping the rewards far earlier than most.
Learn as much as you can, as fast as you can, and apply it!
If you always rely other people to look after you, you’ll always have the instability and stress of dependency hanging over you. What if you lose your job; who will pay the bills? What if you lose your benefits? How will you pay off your credit card? Even if you manage to save £1,000,000 at the age of 30, you’d run out of money if you simply spent, rather than invested.
By learning about financial concepts, improving your financial literacy and generally being a savvy investor, you can build a portfolio of financial assets which look after you; rather than the other way around.
Just as doctors and lawyers spend their entire lives practicing the skills needed for their jobs; you should spend your time learning about investing and personal finance. New investors often assume that wealth is built by hiring a financial advisor, and whilst I recommend finding good mentors, it’s often more efficient to become your own expert; after all, no one will take better care of your money than you!
Conclusion; Save as much as you can in your 20s, invest and protect it to watch your wealth grow!
As I was talking to my friend, I asked him to imagine two scenarios. In the first, he’d saved £100,000, which he held in a Cash ISA paying 2% and never invested. This earned him the grand sum of £2000 a year.
In the second scenario, he’d only managed to save £80,000, but was actively seeking out investment opportunities. Despite having less capital to work with, he managed to earn £1500 a month from his investments which included a rental property, shares and an angel investment with a local business.
In both scenarios, his boiler broke, costing him £800 to diagnose and replace.
When I asked him which scenario he preferred, the answer was an obvious one. In the second scenario, his assets provided a far greater level of income, part of which could be reinvested to increase the overall pot to £100,000 in a short space of time. When the boiler broke, part of that income could be used to pay for it.
By contrast, in the first scenario, when the boiler broke, the monthly income was not sufficient to cover the cost of it, meaning that part of the capital was spent, reducing future income. As inflation ate into the earnings power of his money, he’d gradually have to spend more of the capital to support outgoings, eventually leaving him with nothing.
In short, instead of asking how much you can afford to save in your 20s, aim to squirrel away as much as possible, and then start looking for opportunities to invest it and use your cash to generate more capital to reinvest. Rather than aiming for a single monthly value to save every month; focus on trimming expenses and boosting your overall savings rate.