by Jean Chatzky
Here’s a question I get all the time, it’s this one: How much do I need to save for [insert your own goal here]?
The answer: That depends. If you’re saving for college but you’re only willing to pay for tuition to the in-state university, that’s a very different number than four years at most private schools. If you’re saving for retirement knowing that by the time you stop working your mortgage will be paid off in full, that’s very different than knowing you won’t be finished with that loan until you’re 75. That said, here are some guidelines that can help you at least figure out what your particular numbers may be.
You should have at least six months worth of living expenses – enough to cover the things you need, but not the things you want (cable should get canceled in a job-loss situation; the lights, on the other hand, need to stay on). If you can scrape together nine months worth, even better. (Bigger emergency cushions are especially advantageous in one income families because if that one job is lost you won’t have another to fall back on.)
How I wish there was a universal, one-size-fits-all answer to this question. There’s not. But there are ways to pinpoint a number, and the effort is worth it. If you fail to calculate how much you’re likely to need in retirement, chances are good that you won’t get anywhere close. Studies have shown that only one in five workers are saving enough to meet their retirement needs. Financial experts used to suggest replacing 75% to 80% of your current income in retirement. Now we’re hearing you need to replace 125% to 130%. Why on earth would you need more than you need now? Health expenses, for one.
I say you should shoot to replace 100% of your income. If you can pull together more than that, great. If not, you’ll probably still be okay, though you may need to live more frugally. Note that that includes your Social Security benefits (they average about $1,177 a month). You can find out how much you’re likely to receive there by running a calculation at www.ssa.gov and choosing to see your monthly benefit in inflated dollars. Once you have that, I’d suggest filling out a worksheet, called the Ballpark E$timate, from the American Savings Education Council at www.choosetosave.org. That will help you get even closer to your magic number. Finally, remember that you can always work longer, spend less, or put off taking Social Security for a few years.
There is financial aid for college, but no one is going to subsidize your retirement. Once you’ve maxed out your 401(k), IRA, or other tax-advantaged retirement option, and you have an emergency fund, you can start saving for college. Again, you need a target here, an idea of how much college is going to cost. The College Board issues some guidelines, and this year, they say that tuition, room and board is averaging around $16,000 a year at in-state public colleges. Out-of-state public schools could cost over $28,000 a year, and nonprofit schools may hit $37,000. Do you need to save that much, enough to cover all four years? Absolutely not. For most parents, it’s not even an option. But if you can aim to save about a third of what you think college will cost, you can try to come up with another third out of cash flow while your student is in school, and he or she can borrow the remaining third.
I’m a big fan of putting down 20% of the purchase price. Not all lenders require it, but doing so allows you to avoid private mortgage insurance (PMI), coverage that protects the lender if you’re unable to pay. If you put down less than 20%, the cost of this insurance will be added to your monthly payment to the tune of about $80 a month. How do you get to that 20%? By doing some research on home prices in your area, figuring out how much you can afford, and running the numbers.
A down payment isn’t always essential when you’re buying a car (requirements will vary by dealer) but it’s in your best interest to put something down, and again, 20% of the cost of the car is the rule of thumb here. That number stems from the fact that the car drops in value about 20% as soon as you drive it off the lot. If you put 20% down, you’re not setting yourself up to be underwater. A substantial down payment may also mean a better interest rate.
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