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

Part 3: Check your Expenses

Get your FREE sample of the 100 Steps to Financial Independence Book here

Now you’ve decided on your goals for Financial Independence and have also determined your starting point of what your finances currently look like , it’s time to continue with some practical steps  in order to begin your journey to achieving your financial dreams. In the next 7 parts we’ll be looking at one of the main areas of personal finance in turn, starting with your expenses. 

Part 3: Check your Expenses

In order to get your expenses under control and ensure you don’t have more money going out than you have coming in, the first step is to start a budget and thereby consciously decide where your money will go each month. A budget can be as detailed or general as you’d want it to be, as long as it helps you spend your money on those things you actually want to spend money on. A useful guideline in budgeting is to use the 50/20/30 rule: use 50% of your money for the essentials (such as rent /mortgage, groceries, utilities), 20% for net worth improving expenses (including paying off debt, saving or investing) and 30% for the fun stuff: holidays, eating out and your hobbies.

Once you’ve set your budget and as a challenge to yourself, choose one expense to try and limit as much as possible for the rest of this month. This can be anything from your coffee on your way to work to your utilities bills. Keep aside any money you save from the limit-one-expense challenge for the rest of the month.

This money will be the start of your emergency fund that you are going to build up over the next few weeks / months. Your emergency fund will be your financial cushion for those moments you need to pay for something that is unexpected but crucial in the moment, such as a plumbing expense, car repair or  washing machine replacement. By having this emergency fund you avoid having to go into debt or eat into your savings in order to pay for it. Aim for around $1,000 or the equivalent in your currency.

The last task in the expense part of your financial awareness path is to become aware of the power of lifestyle inflation and take measures to prevent this from happening to you. Lifestyle inflation is the perceived devaluation of one’s lifestyle, resulting in an increase in expenses every time your income increases , in order to live more comfortably: the more you earn, the more you automatically spend, almost without noticing. Think about the last few years when you’ve maybe had a pay rise. How much of the extra money do you end up spending without even noticing? Can you identify where this money is going? From here on try and automatically save (or invest or pay off debt) 50% of any extra money that you get. In that way you avoid spending everything immediately and instead allow yourself to focus on your long-term financial goals.

Find some time today to look at the tasks above to complete to keep progressing on your path to Financial Independence!

The above is an adaptation of part 3 of the 10 parts in the guidebook to Financial Independence100 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 4 of the Journey to Financial Independence: Become Debt 

7 Ways to Invest Some Extra Cash

7 Ways to Invest Some Extra Cash

Last month I received a small bonus from work and after the initial excitement of having some extra money as well as the appreciation and recognition for a job well done, I needed to decide what to do with it, as I didn’t want to blow everything in one go.

How could I make the most of it and allocate it in the best way possible to get bigger long-term results from it? Should I save it, use it to pay off debt, invest it or invest it in myself or my company to generate more income with it?

Here I’ve put together some key points that I hope will be of use to you for when you too find yourself with a little bit of extra money – maybe due to a (small) pay rise, a present or just because you’ve perfected your budgeting skills.

Here are some of the advantages and disadvantages of what you can do with some little extra cash:

Build an emergency fund

What: Save together $1,000 (or the equivalent in your country).

Pros: An emergency fund will allow you to pay for unexpected events without having to go into debt or eating into your savings. I also recommend to build a 6 months living fund with time to cover your expenses for up to 6 months if you find yourself without a job for a prolonged period of time.

Cons: Don’t put more than needed in this savings account, as it will likely not be making you any money due to low interest rates, so once you’ve hit your target amount, put any extra money elsewhere.

Pay off debt

What: Make an extra payment towards your debt, such as a credit card, mortgage or student loan, especially if you have any debts with an annual interest rate over 5%.

Pros: By reducing your outstanding principal, your interest charges go down and so will the long-term effects of compounding interest. The long-term goals of becoming debt-free also means more independence and peace of mind.

Cons: Paying off debt reduces your expenses in the long run, it doesn’t create more money. If you only have outstanding debts with a fairly low interest rate (4% or less), you might get a higher return-on-investment in other ways, such as investing it or generating another income stream with it.

Save

Save money

What: Put the money in a savings account to generate interest.

Pros: It gets you a little closer to your savings goals and it will make you some extra money over time due to interest and most importantly: compounding interest.

Cons: Interest rates are extremely low at the moment and below most inflation rates which means that not only will that money sit idly without making you much money, with time it will also lose value.

Contribute to you pension

What: Make an extra contribution to your private or workplace pension plan.

Pros: By adding more to your pension you’ll not only increase your pension fund, it also allows for it to grow even faster due to increases in returns and its compounding effects.

Cons: Any money invested in your pension plan will not be available until your retirement, you essentially lose access to that money for a long time (or you might be able to take it out before but will need to pay hefty fees.)

Invest in a brokerage account

Invest in the stock marketWhat: Invest the money in your own private investment account to generate interest and dividends.

Pros: Increase your investment funds, as well as the amount of dividends and interest generated to compound without losing access to this money.

Cons: You likely won’t benefit from the same tax advantages that pension funds give and you have to manage your own investments.

Invest in yourself

What: Invest in your individual capital by spending the money on a course, attending a conference or buying books to gain new knowledge or develop your skills.

Pros: Can be tailored to your needs and interest, and can have a long-term effect on your employability, professional development and / or earnings.

Cons: This strategy can be time consuming and prove difficult to see direct financial effect.

Invest in another income stream

Generate another income streamWhat: Set up a company, write a book, buy a property-to-let or find a different way to create another income stream with time.

Pros: Can provide you with a reliable, steady stream of income on the side.

Cons: Can be expensive, hard work, uncertain and unsuccessful.

Which of the above options you ultimately choose depends on your current circumstances: your dreams, plans, job, how much money you have to spend, the risks you want to take, how much time you can and are willing to invest, your family situation and many more. I hope however that the above helps in giving you a better idea of the various options to help you make a decision!

In addition to using your money wisely, if you feel you want to also enjoy a little bit of that extra money now and not just invest it in your future, consider sticking to the 50% rule: invest 50% and keep the rest to spend freely on whatever you want now. Or adapt this to whatever % you want: invest 70% and keep 30%, invest 20% and keep 80%..Whatever you feel happy with!

Day 5 / 31 – Start an emergency Fund

Day 5: Start an Emergency Fund

Day 5: Start an Emergency Fund
Day 5: Start an Emergency Fund

Have you ever had to go into debt or eat into your savings because of an emergency expense coming up that couldn’t wait? Maybe your washing machine broke down and you needed to replace it? Or your car had to get a repair that you hadn’t counted on? Did you ever have a plumbing issues that really had to be fixed as soon as possible?

In most of these cases you often can’t NOT pay for the expense as that would only create more problems, damage or costs. But if you don’t have any money set aside that you can call upon for when these types of unexpected expenses come up, it can be almost impossible to find the money to deal with the problem in the moment without either taking on more debt or using money from your savings that was potentially already earmarked for something else.

The fifth challenge of our 31 Challenges this month is to therefore start putting together an emergency fund. In that way you will always have some money set aside to deal with emergencies such as described above. Aiming for roughly $1,000 is usually a good guideline, but of course adjust this as needed. Continue reading “Day 5 / 31 – Start an emergency Fund”

Step 74: Get one Month Ahead

Step 74 of the 100 steps mission to financial independence: Get one Month ahead
Step 74: Get one Month ahead

This step is a hugely important advance in getting control over your finances with the ultimate goal of moving away from living paycheck to paycheck and instead working towards a situation in which you live on last month’s income. Being one month ahead of your finances takes away a lot of stress and worries and gives a small extra financial cushion in your account. I’ll discuss the advantages and disadvantages of this practice first before looking at how you can implement this.

Being one month ahead essentially means that you are using last month’s income for your current month’s expenses. It means that you are ahead of your finances by having an extra month’s pay in your bank account. The money that you are earning this month won’t be used until next month.

The advantages of getting one month ahead

The biggest advantages of being one month ahead include:

  • It doesn’t matter if you get paid 2 or 3 days late, or if a bill comes in earlier than expected.
  • You don’t have to worry about going out next week instead of this week if you haven’t yet been paid.
  • If a bill is larger than expected or budgetted, you don’t have to worry about not having the money and it gives you time to readjust your budget next month.
  • Lastly, if you have a variable income, you can see a lower income month coming with some warning in order to make any necessary adjustments in your spending .

Continue reading “Step 74: Get one Month Ahead”

Step 27: Build a 3 months living fund

Step 27 of the 100 steps mission to financial independence: Build a 3 Months Living Fund
Step 27: Build a 3 Months Living Fund

Once you have built your emergency fund of $1000 (or the equivalent in yourn own currency) for unexpected or emergency expenses, you are going to continue with the new savings goal in line with our mission to reaching financial independence. In this step we look at the ins and outs of a 3 months living fund and you are going to start working towards putting together this fund.

The rationale behind a 3 months living fund is that it would cover your basic living expenses if for whatever reason you no longer receive an income. This might be because you lose your job, are unable to work or voluntarily decide to take time out of work, for example to care for an elderly parent or sick relative or because you want to take time to focus on something else. It a safety net that ties you over for at least three months that will at least cover your basic living expenses for some months, leaving you time to find a new job, an alternative income or just allowing you to take those three months off before returning back to work. Continue reading “Step 27: Build a 3 months living fund”

Step 16: Start an Emergency Fund

Step 16 of the 100 steps mission to Financial Independence: Start an Emergency Fund
Step 16: Start an Emergency Fund

No matter how organized you are and how carefully you have planned and budgeted for the next month, there will always be surprises that come up and hit you financially at unexpected and often inconvenient moments: a car maintenance or fix that you hadn’t planned for, a plumbing issue that needs immediate attention, a sudden vet bill for one of your pets or your washing machine that suddenly breaks down. I am sure you can think of many occasions and examples that could suddenly happen and throw you off-track.

If you don’t expect an expense to come up, often times you won’t have the money available, and you will either be forced to borrow money, eat into your savings or cut out money elsewhere.

In this step you are going to set up and build an emergency fund, in which you have a certain amount of money put away that you can use in case of these unforseen but needed expenses that come up. In that way you don’t need to worry about scraping the money together, you can just pay the bill and get on with your life. A good amount to aim for is generally $1000 or the equivalent in your currency. Whenever you take money out of this account, you aim to get it back up to the $1000 as soon as possible afterwards. Continue reading “Step 16: Start an Emergency Fund”