The answer to the question “how much should you save each month?” depends on your current individual circumstances and what you are saving for. You may be saving for a deposit on your first home, your children’s education or your retirement. You may be in a position where you cannot afford to save — for example, if you have debts or essential expenditure to pay for.
There’s simply no easy answer to this question.
Be realistic and flexible
To find out how much you can afford to save, you should first draw up a monthly budget of how much comes into your pocket and where your hard-earned cash goes out. Then you can decide on what you could cut back on and determine how much you could reasonably expect to save each month.
The amount you should save also depends on when you start saving. The earlier you start saving, the less you will need to contribute each month.
If you are saving for retirement, you should consider what you would like to do in retirement. How much you should save depends on what you may want to do in the future.
Some people want to travel the world, move abroad or take up a new hobby. Others may want to start their own business or take up a new job. Many people simply retire to be mostly sedentary, even though they prefer not to admit to it.
Make plans, but also prepare for unexpected events in your life.
The question of “how” you save is just as important as “how much”.
Any idea that you should take take risks, or “gamble”, with your savings may seem irresponsible, but being too cautious is just as bad. Keeping all your savings in cash would mean you would be dooming yourself to a low return.
As the interest rate for instant access saving accounts is usually less than the rate of inflation, higher prices in the future usually erodes the spending power of your savings. And, this could mean you may not have enough for retirement or you would have to save considerably more each month.
It is often true that the greater the risk you take, the greater the potential return you should get. But, with more risk, this should also mean the greater the likelihood that you could end up with less than you initially invested.
Investing in stocks and shares
The main attraction of investing in stocks and shares is the potential for higher returns. Since 1900, the average real total return (i.e. returns above inflation and with dividend reinvested) from investing in UK equities has been 5% annually, beating most other asset classes, including property, bonds and cash. And if you shelter your shares in an ISA, you won’t even have to pay any tax on the gains you hopefully make.
Shares may seem like a risky asset class, with shares prices fluctuating on daily basis. And although the value of your shares can fall as well as rise, shares are liquid assets. This means shares can be quickly sold in the market without very much effect on their price. So, while there is a risk that you may get back less than you initially invested, you can at least turn your investments back into cash in short notice.
Jack Tang has no position in any companies mentioned. The Motley Fool UK has no position in any of the companies mentioned. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.