Harry decided it was finally time to lose the extra 10 lbs he'd been carrying around since his kids were born. So he went to his local gym and hired a personal trainer.
Harry religiously met with Jill, his trainer, for 6 weeks. He did everything she told him, including his routine on the days he didn't see her. He initially lost a couple pounds, but soon gained it back. Frustrated, he confronted Jill.
She agreed that he was working his butt off in the gym. "But," she asked "what's your diet like?"
Harry then went on to describe the muffins he eats for breakfast and the burritos he eats for lunch and the cookie (or two) he eats when a coworker brings some into the office. And don't forget the pizza and a cupcake every Sunday night.
Jill explained that losing weight is 80% diet and only 20% exercise. Without eating right, Harry could spend 24 hours a day in the gym and not lose a single lb.
Last week, we explored one of the universal truths about behavioral finance (the study of why people do the wrong thing even when they know what the right thing to do is). If you missed it, you can find it here.
This week's related.
Universal Truth #2: Your Savings Rate Will Determine Your Financial Success
How much you save is your diet. Your portfolio returns is your exercise.
You can't possibly lose weight by only going to the gym. You have to eat right too. In fact, if you want to lose weight, you don't even have to go to the gym. You can just eat right.
Similarly, it's possible to invest all your money in low-yielding CD's and as long as you are saving enough, you could still enjoy a fulfilling retirement.
Alternatively, you could get 20% annual returns and if you're not saving enough you'll be eating cat food in your kid's basement when you retire.
Focusing on how much you save means you're free so spend whatever you want on whatever you want with all your other money. If you are saving (and not going into debt), then you know you are living within your means.
So what's a good savings rate?
20% of your annual income is ideal.
15% is okay.
10% - you're sacrificing tomorrow for today.
5% - pick out your favorite cat food
A 20% savings rate is your "maintenance diet" if you're at your perfect weight. But are you at your perfect "financial weight?" In other words, how much should you have already saved?
According to the personal finance classic The Millionaire Next Door, your current savings should equal 10% x your age x your income. So if you're 50 years old and make $100k per year, you should have $500,000 (10% x 50 x 100,000).
If you hate math like most people, here's a cheat sheet: