How much of your income should you save? You might be surprised


Economists, as it turns out, think savings rates should vary over your lifetime, and even be negative at times. “Economists think about optimal savings rates in a way that is probably counterintuitive to the layperson,” explains Choi.


Instead of targeting an optimal savings rate, economic theory dictates that individuals should focus on discovering their own optimal ‘consumption rate’. That is, what do you, as an individual, like and/or need to consume (given the time you’d have to give up to earn the money to buy them)?

Viewed this way: “The optimal savings rate is whatever the difference happens to be between income and optimal consumption.”

“Because income tends to be hump-shaped with respect to age, savings rates should on average be low or negative early in life, high in midlife, and negative in retirement.”

Get that? Economists are actually fine with you racking up some debts early in life, particularly student debts which increase your future income-earning potential. Then, as you get older, your income will rise, and you’ll be able to set aside a higher proportion of your income as savings, while still funding a similar level of consumption.

Avoiding ‘lifestyle creep’ is key, and economists call this whole process ‘consumption smoothing’.

Choi even goes so far as to say the government policy of requiring all workers, regardless of age, to contribute the same percentage amount of their salary into super each year is ‘sub-optimal’ from this perspective.

Still, most personal finance experts push back on this grand theory for two reasons; the first being the importance of building a discipline around saving at an early age. The second being the power of ‘compound interest’ – the idea that money you earn on your money over time starts to earn its own money, compounding returns over time. The earlier you start on the compounding journey, therefore, the better for long-term returns.

Which is all well and good. What worries me about fixed percentage savings targets is if young people or people on lower incomes feel saving 20 per cent of their income is just not achievable and disengage altogether.

Conversely, it also worries me that higher-income people could actually save less than is desirable because they let their consumption spiral thinking they only need to set aside 20 per cent of a rising income.

When it comes to managing my own money, I’m more an economist than a personal finance writer.

I don’t have a fixed target savings rate in mind and I don’t automate my savings. Instead, I spend time at the end of each month tracking and reflecting on my actual spending. Being actively engaged with where my money goes helps in several ways. It helps me guard against waste, identify areas for improvement, ensure my spending aligns with my values and consider whether the money I am spending today brings me more joy than if I saved the same money for Future Jess to spend.

It’s a process as much about figuring out who I am, and what I like, as it is about saving money. And in my experience, such a process of self-discovery and reflection pays a dividend greater than money could ever buy.

  • Advice given in this article is general in nature and is not intended to influence readers’ decisions about investing or financial products. They should always seek their own professional advice that takes into account their own personal circumstances before making any financial decisions.