10 Common Questions about Saving

The median American household had only $11,700 in savings and 29% of households have $1,000 or less, according to a recent CNBC article. Whether it is retirement savings or savings for a specific long-term or short-term specific goal, there are many reasons why we should crank up our savings and boost our financial security.

This third article in the “10 Common Questions…” discusses the essentials of savings, including how much savings you should have, your savings rate and what you should actually be saving for.

Q: What classifies as savings?

Savings can include a variety of things. Some people refer to just their money in a savings account as their savings, but there are a few more savings to consider. Really “savings” refers to “any money you have set aside waiting to be used at a future time”. With this definition contributions to retirement funds as well as investments made can also be classified as savings.

Another way to describe savings are “any payments that improve your long-term finances”. This adds yet another option: paying off debt. After all, by paying off debt, you take away the interest charges as well as your dependency on your creditors.

In short, savings can be any or all of the following:

  • savings account
  • retirement fund
  • investments
  • debt payments

Q: How can I save if I never have any money left over at the end of the month!

A not uncommon situation that many people can find themselves in is that they have no money left at the end of the month, let alone any money to make those savings contributions.

But the solution to this problem is answered by the problem itself: “I never have any money left over at the end of the month.” If you wait until the end of the month to set aside money to save, other expenses become a priority. Whatever you allow to be paid closer to the beginning of the month, will naturally have a higher chance of being purchased as there is a higher likelihood that money is still available, whereas the closer towards the end of the month you leave a payment, the lower the probability that there is any money left over.

So in order to start saving you need to change your habits: put your savings allocations to the start of the month and make this one of the first payments you make. Then, with whatever is left, you need to make ends meet and not spend more than you have coming in. By switching the order around you ensure that you hit your savings targets AND stay within budget for the rest of the month.

Q: But currently interest rates are terrible!

At the time of writing, interest rates are indeed extremely low, often even below inflation. But there are several pro´s to keeping up your savings rate:

  • An emergency fund means that you don’t need to borrow money and go into debt if you need money for an emergency.
  • Cash is king, and having some funds available immediately when needed is a huge peace of mind.
  • If you are looking for higher returns upon investments, instead of setting money aside into a savings account, consider investing the money or adding more to your retirment funds.
  • Another way to use your money if you don’t want it to sit idly in a savings account is to pay off debt faster. In this way you avoid the accummulation of interest payments.

Q: How much should I save per month? 

You should save how much you can and want to save each month, but a common answer to this question, at least to start with, is to save 20% of your net income. (This is based on the 50/20/30 rule that says to aim to spend 50% of your money on essentials (rent, food, utilities), 20% on savings goals and 30% on discretionary or fun expenses (holidays, nights out) ). Of course, these are only guidelines, and since your situation is unique you need to decide for yourself how much you can really save. But it’s a good starting point if you are not sure what a good amount would be. As your lifestyle is so different to other people’s, using a savings rate is much more helpful than using specific amounts.

Q: What’s so important about this savings rate?

Your savings rate tells you how much of you income you don’t need for your day to day life. The higher your saving rate, the less you live off. This is helpful in two ways:

  • If you lost your job or were without an income for a while, it means you need to eat into your savings less simply because you’ll need less money to pay your bills.
  • The more you save, the sooner you hit your savings goals.

Let’s look at an example. Say you earn $2,500 net a month and that you save 10% of this money $250 and therefore spend the remaining 90%: $2,250. That means it would take you 54 months to save up for a 6 months living fund ($2,250 x 6 / $250).

If instead of saving 10% you were able to set aside 20% each month, your monthly savings would be $500, your spending would be $2,000 and it would only take you $2,000 x 6 / $500 = 24 months to get together that 6 months living fund.

Q: What is my savings rate?

You can quickly calculate your savings rate by looking if you know your last month’s income and savings. If you keep a register of everything that you spend and save, this process is even easier, but even if you don’t and you need to work of approximations, that is fine too. To calculate your savings rate, find out how much money you allocated to  savings expenses: this includes contributions to your savings accounts, retirement provisions, paying down debt and investments. Total these amounts, then divide this by your total net income.

If you set aside $50 in your savings account, $100 towards your retirement, $75 to pay down debt and invested $75, your total savings expenses were $300. If you take home $2000 each month that gives you a savings rate of 15%.

Q: What should I be saving for?

  • Emergency fund – for any emergency expenses that are unexecpected and that you have to make in the moment, for example when your car or washing machine breaks
  • 3 – 6 months living fund – to cover your expenses if you suddenly find yourself without an income
  • Specific targets (vacation, new car, children’s education) – these can be adapted depending on some of your own personal short term and long term plans
  • Retirement – this can be in the form of a retirement fund or your own private investments

Q: What are some savings targets I should aim for?

Although there is no ONE answer to how much you should have in savings, here are some common guidelines that you can use in order to decide for yourself how much to save:

 

Q: paying off debt, savings, retirement funds, investing… what should I be doing? 

In order to truly cover yourself in all financial areas, you want to be doing pretty much everything. But of course, you’ll likely not have heaps of money available to do all at the same time to the maximum amount that you’d ideally set aside. So what should you be focusing on? Here’s a helpful guideline that you can use and adapt to make it work for you.

  • Start doing ALL of the above, but start small with those that are less of a priority right now (for example investing) if you still have other ones that are more urgent (paying off consumer debt or saving at least 1 months of expenses).
  • Decide how much $ you can put aside each month, then allocate a % of that money to each of your savings, for example: 70% paying off debt, 15% saving, 10% retirement fund contributions and 5% investing.
  • Every 3 months, re-evaluate your % as well as your monthly total amount you can save and re-adjust where possible. You might decide that once you’ve paid off all your consumer debts with an interest rate of over 4%, you reduce your % to pay off debt to just 40%, using the remaining 30% to boost your savings or to one or several of the other saving goals you have.
  • I’m a huge fan of scheduling dates as those three months will otherwise fly by and be forgotten about, so block in this appontment with yourself already!

Q: Where should I start?

  1. Begin by putting away a set percentage of your wage. If you need to begin small then that’s okay. This could be 5% or even just 3%. It’s better to start small than to not start at all.
  2. Set saving goals and if possible open different bank accounts for each one. Saving goals can be anything from short to long term.
  3. Decide on your savings allocation for each goal: Of all the money you set aside each month, set aside 50% for goal A, 30% for goal B, 10% for goal C and another 10% for goal D for example.
  4. Little by little start increasing your savings rate, until you get to your ideal savings percentage..

This article is part of the “10 Common Question series”, where I address issues about some key financial areas, including Financial Independence, paying off debt, increasing your income, retirement provisions, saving, investing, financial protection and much more. If you want to find out more about Financial Independence, you can sign up to my newsletter to stay up to date or get a free sample of my book 100 Steps to Financial Independence. 

Image by Andreas Breitling from Pixabay

10 Common Questions about Debt

The average US household debt is over $135,000 according to a recent study by Nerdwallet, in the UK it is just under £60,000. Those are huge amounts yet most of us see having debt as a “normal” part of life and might not even think twice about the implications of all these loans.

In this second article in the “10 Common Questions…” series we’ll have a closer look at debt, the advantage of becoming debt-free, different ways to pay off your debt and how to stay out of debt long term.

1: Why is paying off debt so important? 

Becoming debt free has many different advantages. One of the main ones being that it will save you a LOT of money. Debts are hugely expensive, much more so than most people realize. By becoming debt-free you are no longer wasting money on a loan for something you might have purchased months or indeed years ago. 

Another key reason to become debt free is to no longer be indebted to anybody else and take complete control over your money. Whether you have a loan from your bank, a store or the government, when you’re debt free, nobody but you can make a claim on your money.

If you do ever need to take out a loan, such as for a big purchase like a house, you’re also much more likely to get a loan and with better conditions. The more responsible you show you can be with money (i.e. not have lots of outstanding debts), the more likely you will be able to pay back your mortgage, the less of a risk you are to a bank, meaning they are more likely to grant you the mortgage and at a lower interest rate. 

2: But doesn’t everybody have debt? Is’t that just part of life?

Having debt has certainly become the default for most people and indeed for society as a whole. We see having debt as a standard thing in life, but that of course doesn’t mean that it’s actually the BEST option to pursue. Having debt costs money, ties you to your creditors and might keep you in a job you don’t enjoy simply because you need to pay all those creditors. 

Added to that, if you are looking to progress and get ahead or indeed pursue Financial Independence, you don’t want to do “what everybody else is doing”. If you want to achieve different results, you need to do different things to what other people do. How many people do you know who have debt? And how many of those are Financially Independent? I think that says enough. 

3: But my interest rate is only 1.5%. Surely that’s not so bad? 

A trick that many credit providers use is to state their interest in monthly percentages, when really you should be looking at the yearly percentage. A 1.5% interest rate means the annual interest rate is 18%. That sounds a lot more serious, doesn’t it? 

Let’s look at a quick example of what 18% means in terms of the total costs for you. 

If you had a $1,000 credit card loan at a 1.5% monthly rate and an agreed payment plan of 3% per month (meaning each month you pay back 3% of the outstanding balance you owe) and a minimum of $10, you would pay back the incredible amount of $1,779 in total on this loan! Not only that, in addition to the nearly $800 in interest you pay, it would also take you 9 years and 10 months to pay off this loan. That’s a huge amount of time for a loan of $1,000 at “just” 1.5%. 

4: But what about that new car / planned holiday / latest gadget I want?

Living with debt and therefore buying something before paying for it, has almost become a standard way of life: something many of us don’t even think about anymore and take for granted. But it doesn’t need to be like this. A much healthier, cheaper and satisfying way to purchase something new is by being able to pay for it up front instead of by financing it.

In order to do this, you’ll need to set up savings goals and plan ahead about when you might need to make a bigger purchase, such as that new phone, your holiday or replace your car. Once you’ve got a goal you can work backwards and decide on a set amount you need to put aside each month in order to be able to have the money saved up at the time you expect you might need the money to make the purchase.

Becoming debt free doesn’t mean you can’t get that new gadget, it just means you save up the money first before you purchase it and just requires a little bit of planning (and patience!). 

5: How long will it take to pay off my debt?

Of course this depends completely on how much debt you have and how much you are able to free up to pay towards this debt each month. There are many excellent online debt calculators available that can quickly show you just how long exactly it will take you to pay off each one of your debts. Let’s have a quick look at an example to show you how fast it might go though. 

Let’s use the same loan from earlier as an example ($1,000 loan, 18% interest rate, 3% monthly payback with a minimum of $10). If you were able to pay an extra $25 each month in addition to what you get charged by default by your credit card company, you would “only” pay $221 in interest, over $550 less than the original $779! Added to that, with the extra $25 a month you pay, it would take you just 31 months to pay off the loan (a little over 2.5 years) instead of the 118 months mentioned earlier!

As each loan and situation is so different, I recommend you use an online calculator to play around with some different numbers of how much you might be able to pay off extra each month and see what the effects of this are on the total costs of your loans. If you have more than one debt it’s important to choose the right strategy for you when it comes to paying off your loans: using either the snowball or the avalanche technique.

6: What’s this “snowball” technique?

The snowball debt repayment technique recognizes that paying off debt isn’t just a numbers game where all you do is consistently paying some money towards your debt. There is a substantial psychological component involved in this process too, more specifically: motivation.

Your motivation to get started on paying off your debt, your motivation to keep going even when the journey becomes dull or hard and the motivation to stick with the adjustments you need to make to your spending habits. 

The snowball technique encourages you to start with the smallest debt that you have, and begin to pay down this debt as fast as you can. In the mean time you keep making the minimum contributions to any other debts you have, you don’t want to accumulate more interest or penalties than needed after all.

By beginning with the smallest debt you will pay this off relatively fast, giving you a quick motivation boost as you witness the results. Then you move on to the next smallest debt for which you now pay off the minimum amount you were already paying + the money freed up from the first debt. Each time you pay off a debt, you free up more money to start paying off your next debt.

7: What about the “avalanche” technique?

The avalanche technique is similar to the snowball debt payment technique with one difference: instead of starting with your smallest debt, you begin paying off the debt with the highest interest rate. This is after all the one that, when left over time, accrues the highest amount of interest on it, meaning that by paying this one off first you save yourself a lot of money over time.

Like in the snowball technique, make sure to continue to make the minimum contributions to any other debts you have whilst you pay off your highest interest one, to avoid extra charges.

8: How can I stay out of debt?

There are three key things you can do to avoid going into debt again. The first one is to ask yourself whether you really need what you’re buying right now at this price. Is there a cheaper option available that would do? Can your old phone last another 6 months? Can you wait for a newer version to come out and buy the discounted older version? 

The second habit to develop is to set up savings goals and plans: if you know you’ll need a new phone in the next few months, then start saving up for this today by consistently setting aside money until you have the money available. 

Thirdly, accept that sometimes life throws a curve ball at us that can lead to instant costs you just have to pay in the moment: a broken washing machine, a car maintenance or a vet bill that you just need to get done in the moment. For these emergency situations, make sure you have an emergency fund available: start building up $1,000 set aside that you only use for these emergencies. 

9: Paying off debt… then what?

Once you get rid of all debt, and have put in place measures to avoid going into debt again in the future, that’s a huge achievement in itself and most definitely is something to be proud of. But it is only one of the pillars on your road to Financial Independence. There are other steps you can take, in the area of your income, investing, retirement that you can now focus on towards a secure financial future.

Commit to moving on to the next area of your finances and continue your journey towards Financial Independence. (One way to do this is of course to make sure you follow this series of articles!).

10: Where do I start?

The road to becoming debt-free isn’t easy but certainly worth it, so if you are committed to paying off all your loans, here’s what you can do:

  1. Find out all you can about your current debts: outstanding amounts, yearly interest rates and monthly payback amounts.
  2. Start by paying off extra money towards 1 debt using the debt snowball or avalanche technique. Free up extra money from a yard sale, a side hustle or by picking up extra hours at work. 
  3. Make sure to stick to your minimum payments on all other loans, don’t default on those monthly payments.
  4. Once you’ve paid off one debt, use all the money you’ve freed up from no longer needing to pay off that debt to start on your next loan. Keep at it until you’ve paid off your last debt.
  5. Start building up an emergency fund to avoid having to go in debt in the future.

This article is part of the “10 Common Question series”, where I address issues about some key financial areas, including Financial Independence, paying off debt, increasing your income, retirement provisions, saving, investing, financial protection and much more. If you want to find out more about Financial Independence, you can sign up to my newsletter to stay up to date or get a free sample of my book 100 Steps to Financial Independence. 

Photo by Republica from Pixabay

Day 9 / 31 Start paying off your debts

Day 9: Start paying off your Debts

Day 9: Start paying off your Debts
Day 9: Start paying off your Debts

Today’s challenge is to put in a plan of action to start paying off your debts. Now that you have seen how much a debt costs you and how much extra you are paying in interest in yesterday’s challenge, this is probably the best moment to kick those wretched loans to the curb as soon as possible.

Once you start paying of your debts you are beginning to regain control over your financial life, little by little lifting the strain of monthly payments and the psychological burden of being indebted to somebody else. Continue reading “Day 9 / 31 Start paying off your debts”

Step 70: Pay off your mortgage

Step 70 of the 100 steps mission to financial independence: Pay off your mortgage
Step 70 : Pay off your mortgage

Now that you’ve been through the various steps on expenses and budgeting, saving, pensions, investing and planning for your future, it’s time to go back again to the bit on debts with one debt in particular which is probably your biggest debt: your mortgage (providing you have one – otherwise you can skip this step). We of course spoke about paying off debt at the start of our mission, but as we said there, since your mortgage has a lower interest rate than most of your other debts, chances are you haven’t yet started paying it down faster.

As commented before many people would argue that a mortgage is a different type of debt and therefore not to worry about as much as they see having a mortgage as an investment. At the end of the day they say, your house is an asset that will probably increase in value over time. I disagree for several reasons:

  •  first of all it isn’t the same type of assets such as stocks and bond that you can just sell to generate some extra money. The only situations in which you can argue that your house is an asset like any other is when you don’t need it anymore for example because you decide to:
    • travel
    • move in with somebody else
    • live in another house that you already own or rent
    • scale down and don’t need a mortgage on a new house
    • live on the streets
  • secondly, you never know when you can sell your house. Some houses are on the market for years, so liquidating that asset isn’t as easy as with other assets.
  • thirdly nothing guarantees your house will truly increase in value or have increased in value by the time you need or want to sell. During the recent house market crash, many houses were sold below their original purchase price.
  • fourthly you are still losing money by having a mortgage in the form of interest payments and you are tied to paying back regularly so until you pay off your mortgage in my eyes this is a debt that takes a big toll on your monthly finances.

Continue reading “Step 70: Pay off your mortgage”

Step 24: Become debt free

Step 24 of the 100 steps mission to financial independence: Become debt free
Step 24: Become debt free

Becoming debt free might or might not have been a goal you identified when you put together your principal financial goals in step 2. Whether this was the case or not, you hopefully have realized that becoming debt free is possible with some extra effort and money, and in your interest (no pun intended) if you want to avoid paying the extra costs of oustanding loans. It might take you three years, 10 years or 20 years, but being able to say you have finally paid down all your debts is a huge achievement. And as we saw in the last few steps, the time it takes to pay off a debt can be sped up incredibly by making extra payments.

The next part of your mission and the main focus of this current step is for you to set yourself goals to pay off your debts. You will set yourself a target date to pay off the first debt that you have already started working on, then for each and every other debt you will do the very same, all the way to the very last debt you will be attacking. That will be your target date to becoming completely debt free. Continue reading “Step 24: Become debt free”

Step 23: Start paying off 1 debt

Step 23 of the 100 steps mission to financial independence: Start paying off 1 debt
Step 23: Start paying off 1 debt

From the previous step you are now up to speed about the positive effect of extra payments on outstanding debts. That leads us to the current step: start paying off a debt. You might think you are already paying off a debt, or several of your debts, but the point here is that you are going to pay off a debt faster by making higher monthly contributions than the minimum required.

When you pay off a debt faster than scheduled, a few amazing things happen:

  • You end up paying less interest, resulting in a lower amount of money paid back overall;
  • It takes less time to pay back the loan, meaning you can tick it off your list a lot sooner;
  • Psychologically it is a great relief to have paid off a debt: one less thing to worry about;
  • It increases your motivation by showing you that you can achieve your goals;
  • And here’s a great thing: once you’ve paid off a debt, that monthly amount you poured into this debt suddenly becomes available, which you can then use in its entirety to pay off another debt, meaning it keeps up that momentum!

Continue reading “Step 23: Start paying off 1 debt”

Step 22: The impact of extra debt payments

Step 22 of the 100 steps mission to financial independence: The Impact of Extra Debt Payments
Step 22: The Impact of Extra Debt Payments

After some rather depressing news to do with debt and interest, it is again time for some uplifting information. In this step we are going to look at how powerful it can be to put extra money towards paying off a loan and how much it reduces not just the time spent on paying back the money, but also the total amount paid back.

This information will hopefully inspire you to find ways of making extra payments towards reducing your debts. As even if they are small extra payments, in the long run, thanks to that friend of ours called compound interest, it will have a huge effect.

Let’s go back to the same example as the one I used in step 21 to illustrate how credit cards work, in which we looked at an outstanding debt of $1000, at a 1,5% monthly interest rate and a payback rate of 3% with a minimum of $10. But this time you make an effort each month to pay the minimum amount (3% of the outstanding debt) and an EXTRA $25 on top of the minimum amount. Let’s see how this works out. Continue reading “Step 22: The impact of extra debt payments”