How to accumulate 6 months of salary in 5 years
The Sunday Nation
Nairobi,
28 August 2011
In the last two articles, we found that it is better to think about wealth in terms of duration instead of a cash value. The question then is: how does one set a savings target in this new thinking?
It is generally advised that one should save at least 10 per cent of their income every month. Working this way, one can accumulate about 6 month’s worth of the original income in five years. But if a pay rise is awarded along the way, then the 6-month target will not be achieved.
Going back to the case of Rachel Andeso whose current salary is Sh30,000, we now ask what percentage she should save monthly in order to achieve the 6-month wealth target in five years time. We shall assume that she gets a 15 per cent increment every year during the period.
The first step is to establish her expected salary after five years. Starting from Sh30,000, it is clear that her income in the second year will be Sh34,500. This the rises to Sh39,675 in the third year; then to Sh45,626 and Sh52,470 in the forth and fifth years respectively.
So, by the end of five years, her net salary will be about Sh52,470 and this will increase to Sh60,340 per month at the beginning of the sixth year. In the new thinking about savings, Rachel should aim to have six month’s worth of income in her bank account at this point.
Therefore, we should simply multiply her expected monthly salary by six to get the cash value of her savings target. But an interesting question arises: do we use Sh52,470 of the fifth year or Sh60,340 of the sixth?
Well, since we are looking for a savings target AFTER five years, we should use the salary at the beginning of the sixth year, that is Sh60,340. Multiplying this by six gives Sh362,040. This is the amount of money that Rachel will need to have in her savings account at the END of the fifth year.
So the question is: what percentage of the monthly salary should Rachel save in order to accumulate Sh362,040 by the end of five years? The answer is found by dividing the targeted savings by the total cumulative income earned during the period.
Rachel earns Sh30,000 monthly in the first year. This is equal to Sh360,000 in 12 months. Then this rises to Sh34,500, or Sh414,000 in the second year.
The subsequent amounts are Sh476,100, Sh547,515 and Sh629,642, for the third, fourth and fifth years, respectively. The total cumulative earnings at the end of the period is simply the sum of all these annual amounts and it comes to Sh2,427,257.
To find out what percentage of monthly salary to be saved, we divide the target amount (Sh362,040) by the total earnings (Sh2,427,257). The result is about 15 per cent.
Now, can Rachel afford it? Well from her initial calculations, she had about Sh16,500 that she couldn’t account for. 15 per cent of Sh30,000 is only Sh4,500. Therefore I think she can manage.
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