Do you think people with high incomes are wealthier than people with average incomes? This is a myth that needs to be dispelled.
Many people have extremely high incomes, but their net worth does not reflect the high income.
The key is not how much you earn, but how much you save. The amount you save is the primary factor in becoming financially secure.
Many people with a high income live a “high-consumption lifestyle” in which they spend everything they earn. Oftentimes, they spend more than they earn, resulting in being in debt. This is a common example of “living beyond your means,” and these people tend to be very status-driven, as they strive to “keep up with the Joneses.”
Clearly, you do not want to follow this destructive – but very common – path.
In the classic financial book “The Millionaire Next Door,” Thomas Stanley researched the common traits of millionaires during the 1990s. He discovered that on average, they saved and invested 20 percent of their income.
How much of your income do you save? Most people do not know. I recommend that my clients save at least 15 percent of their gross income, and preferably 20 percent or more. A high savings rate is the very best way to ensure that you will not run out of money during retirement.
The first step in increasing your saving is to calculate how much you are saving now. Look on year-end tax documents or investment statements to see how much you contributed to your retirement plans last year (401k, 403b, Roth 401k, Roth 403b, IRA, Roth IRA). Do not include the amount your employer contributed – only include your contributions (and your spouse’s contributions). Write down the amount. If you saved money in a bank account or a taxable account, add that amount to your list. However, only include the money that was truly saved for the long-term. If you spent the money later, or if you withdrew money during the year, it should not be counted as savings.
Calculate the total savings. Take this total, and divide it by your pre-tax (gross) income. This figure can come from your last paycheck of the year, or from your 2012 IRS federal tax return under “wages, salary, tips, etc.” If you and your spouse are both earning a paycheck, add your incomes together. (If you are self-employed, use your income from Schedule C or from a corporate tax return).
What is your savings percentage? If you contributed $6,000 to your 401k and you earned $50,000 (gross), then you saved 12 percent ($6,000 ÷ $50,000). If you saved a total of $15,000 (in any combination of retirement accounts, taxable investment accounts, or savings accounts) and your income is $100,000, then you saved 15 percent ($15,000 ÷ $100,000). If your income is $150,000 and you saved $30,000, then your savings rate is 20 percent ($30,000 ÷ $150,000).
Knowing your savings percentage is a big step forward. Most Americans save less than 5 percent and many do not save at all. The next entry in this blog will give you tips for increasing your savings percentage.
Photo by: Anthony Crider
