Now you’ve started paying off your debts and are (however slowly) working towards becoming debt-free, your next stop on your journey to Financial Independence are your savings, with the aim to increase these little by little.
Part 5: Boost Your Savings
If you’ve already put together your emergency fund with (the equivalent of $1,000 which we looked at in Part 3, now is a good moment to saving together a second fund: a Three-Months-Expenses fund. As its name suggests, this fund should have enough money in it to cover 3 months’ worth of expenses. See this as a safety net should you ever decide to take an unpaid leave for up to three months or find yourself without a job for a while. In this way you have at least three months covered before you need to replace your income. Calculate how much you need for this fund, then plan how and when to start making contributions.
Another valuable step when looking at your savings more detail, is to work out your savings rate, which is the percentage of your income that you save monthly.
If you have a net (take home) pay of $1,500 and you save $150 every month, your savings rate is 10%.
This is important for two reasons: if you increase your saving rate, you not only save more money, you also need less time to put your Three-Months-Expenses fund together and will need less in your retirement fund as well as any other future savings target, since you manage to live of less.
If you take home $1,500, save $150 and spend the rest each month, you need Three-Months-Living fund for $1,350 x 3 = $4,050. With a monthly saving of $150 it will take you 27 months to get this fund together. If instead you increase your savings to $300 a month, you need just $1,200 x 3 = $ $3,600 in your fund and with $300 a month you save this in only 12 months.
Calculate your savings rate today and find ways to increase this ever so slightly to see the effects of it on your Three-Months-Expenses Fund.
A third task to complete when looking at your savings is to commit to keeping 50% of any extra money that you make. This means that if you get a bonus, extra holiday pay or a reduction in your mortgage payment, that instead of going out to celebrate and spend all the money you just got, you instantly set aside 50% of your money in order to improve your net worth and financial situation: putting it in a savings account, using it to pay off debt, making an extra contribution to your retirement fund or investing it in the stock market. After you’ve done that you’re free to use the remaining money to spend as you like 🙂
Lastly sit down for a moment today and define some of your savings goals, both short-, mid- and long term and determine how much you need for each goal and when you’d like to achieve them by. Examples of short-term savings goals could be a new phone or a holiday in summer: they are usually goals you aim for within the next two years. Mid-term goals take about three to ten years to achieve and might include a downpayment for a new house, planning for future children or buying a new car in cash (i.e. without a loan). Lastly the long-term goals take more than ten years and can include your retirement or saving up for your child’s college fees. Identify a few goals in each of those categories, but know that you don’t have to start working towards all of them at the same time. Some might stay “dormant” for a few years before you’re ready to start saving up for them.
Find some time today to look at the tasks above to complete to keep progressing on your path to Financial Independence!
This post is an adaptation of part 5 of the 10 parts in the guidebook to Financial Independence: 100 Steps to Financial Independence: The Definitive Roadmap to Achieving Your Financial Dreams where you can find more details as well as action plans and guidelines to each of the 10 parts. Available in both ebook and paperback format!
Coming up next: Part 6 of the Journey to Financial Independence: Your Income.