Intro to Saving: Avoid Breaking the Bank
It was senior year of college. I was working 30-something hours a week at a restaurant, and wrapping up my business school classes for the semester. Besides basic expenses like rent and food, I was actually beginning to save a decent amount. What will I spend this on? I thought.
And then, life happened. Some friends needed help to pay for a class. In the same week, on my way home from work, I drove over a particularly brutal pothole that absolutely demolished parts of my car. Plus, I had to purchase a flight to Texas for a conference later that month.
Life events have a way of happening all at once. Between helping my friends and the car repairs, I didn't have enough for the plane ticket. Later, I ended up driving to Texas instead. (In hindsight, that was a very foolish move that was easily more expensive in the long run, but I chafed at the idea of borrowing money). Those costs brought me down to nearly my last penny. I just barely made rent the next month by the grace of God.
The point is this: Life is unpredictable, and we need to be prepared for its inevitable twists and turns. Living paycheck-to-paycheck is not a sustainable lifestyle, and most people have the ability to climb their way to financial freedom. With a little more preparation and intentional budgeting, we can avoid finding ourselves in unnecessarily difficult circumstances.
Obviously, you cannot prepare for everything. But having a contingency plan can make unexpected circumstances much easier to deal with when they do come. To start:
1) Set a goal
First and foremost, you have to set a goal for your finances. Simply saying, "I want to be in a better financial situation a year from now" or "I want to become stable" are not specific enough. Without a clear sense of direction or point of reference, you can end up "trying" to be more effective or efficient with your finances without ever actually making the necessary changes.
For example, if you currently have credit card debt that you cannot pay off in time, set a goal to "Pay off your credit card debt completely in 3 months". If you've already done that, and you have a large upcoming expense like travel, engagement ring, or wedding, set a goal to "Save up $ for [winter vacation plans] by [December 1, 2018]". The key is to have both a clearly defined goal and a specific timeline to accomplish it.
1a) Determine target savings rate in order to accomplish this goal in the given timeframe
This means starting from the bottom line. If I need to save $24,000 for a car in a year (sidebar: always pay for depreciating assets like cars in cash if possible), then I need to save an extra $24,000 / 12 months = target savings rate of $2,000 per month. Does it sound unreasonable? Change your goal or change your timeline. Maybe I don't need a $24,000 car, but a $10,000 car instead. Or maybe I still really want that specific car, but I'm willing to save for a longer period of time to achieve that.
2) Analyze your income
Figure out how much you make in a month net of taxes. I imagine you should already be tracking this carefully. But just in case, look up your bank statement or your W-2 pay stubs. If you have any other sources income (rent, dividends, bonds, advertising, etc), include that as well. I would exclude unrealized gains from appreciation of assets (whether in stock or property), as that can swing either way month-to-month.
3) Analyze your expenses
Download your bank statement information and go through at least two months' worth of data. Categorize every transaction and place them in different buckets: rent, utilities, groceries, restaurants, shopping, gifts, travel, donations, entertainment, investments, subscriptions, etc. Most major banking portals already do this for you. Alternatively, you can link your bank account to sites like Mint that will help to categorize your spending. Identify transactions that look unusual or irregular.
Completing this step can produce especially surprising results. Wow, did I really spend that much eating out last month? or I didn't even realize I was still subscribed to that service.
4) Determine your current savings rate
From here, you can calculate your current savings rate as both a percentage and a total dollar amount. For example:
Income after-tax: $4,500
Other expenses: (1,600)
Monthly savings: $900 => 20%
5) Determine adjustments needed to reach target savings rate
Calculate the difference between your current savings rate and your target rate. Taking the above examples, the target savings rate is $2,000 per month, whereas the current monthly savings is $900. This means there are $1,100 of additional savings needed.
6) Trim the fat
Rather than trying to reduce the amount spent on any particular bucket, like entertainment, groceries, etc., try to achieve your target savings rate by reducing the large, unusual expenditures. Big, unnecessary purchase on clothes you don't really need? Cut it. Did you have to upgrade your phone this year? Wait another year next time. Trying to track each individual budget can be cumbersome and difficult to implement. Simply pursuing your target savings rate can be a better solution.
For example, this month you may have to purchase airfare for upcoming international travels. Or perhaps you are treating out your family to a fancy dinner for a celebration. These events will almost certainly blow through your average monthly budget. Instead of tracking every bucket, it may be best to see how you're trending toward your target savings rate for the month. If you're halfway through the month and already at 75% of total spending budget, maybe you cut back on eating out, and only cook for the rest of the month.
7) Execute and track progress
Monitor your progress and track your goals regularly. You may find your original goal was too ambitious or too easy. But after landing on a goal that will stretch you, but can reasonably be achieved, start pushing through those limits. My personal advice would be to reach a point that feels slightly uncomfortable, meaning your budget is still actively stretching you to be a little wiser or more conservative with your money. Once you've reached this point, maintain your new spending habits until they become ingrained, and start working on developing passive income. With each raise or windfall, do not upgrade your lifestyle (unless necessary), and pocket the gains.
With some discipline and experience, any person can make significant progress in achieving their financial goals.