For many of us, saving money can be a challenge.
We know we should be doing it, but we don’t for a number of reasons.
Either we believe that we don’t have enough money to be able to save it or we just don’t know how to budget. The truth is, regardless of the reason we don’t save, anyone can learn to budget and begin saving.
If we are willing to put the effort into the planning needed to set up a budget and develop the discipline to stick to it, there’s no reason why we can’t save. So, if you are first trying your hand at budgeting or if you’ve already tried it, but were not as successful as you would have liked, here’s a step-by-step guide to building your savings.
- Know your income
- Develop a budget
- Sort expenses by category
- Figure out how much money is left after paying for necessities
- Adjust spending
- Create an emergency fund
- Pay off short-term debts
- Establish a retirement fund
- Set aside funds to meet short-term goals
- Invest remaining funds
Now that we know the steps needed to save, let’s look a little closer at each one.
1. Know your income
While most of us know how much we earn, not everyone knows how much they actually take home. If we work, we hand a portion of our paycheck over to the government in the form of taxes. There’s no getting around it, so we need to know how much money we have remaining after we’ve paid our taxes and base our budget upon that amount.
If the tax rate is 25% and our annual salary is $60,000, we have $3,750 left per month when all is said and done. This post-tax amount is what we need to use when budgeting.
2. Develop a budget
How many of us know exactly what we are spending each month? A lot of people don’t track what they spend and without this information, we don’t know how much we can afford to save.
To create our budget, we should begin by listing all of our monthly expenses. These should include the expenses listed below.
- Groceries- food and household items
- Mortgage payments or rent
- Personal care items- clothing and toiletries
- Transportation- car payments, gas, tolls, vehicle maintenance, repairs, insurance and transit fares
- Debts such as credit card and student loan payments
- Healthcare- insurance deductibles and premiums
- Utilities- electric, gas, water, heat
- Cable, internet and cell-phone
- Gifts and obligations
- Memberships- gyms, etc.
We should also make sure to add in any one-time expenses when figuring out our monthly costs. We will divide those expenses over 12 months. So, for example, if we pay an annual membership fee of $1,200 for a health club, we will add $100 to our monthly expenses even though it is not a recurring fee.
3. Sort expenses by category
I recommend dividing expenses into two categories- needs and wants. In the needs column we are going to include essential and unavoidable expenses. Food, rent, healthcare and transportation fall into that category. In the other column, we have non-essential expenses such as eating out at restaurants, seeing a movie or buying a new television. We all like having nice things and experiences, but we could still survive without them.
4. Figure out how much money is left after paying for necessities
Now that we are aware of how our money is being spent each month and understand what our needs are versus wants, let’s start figuring out how much we may be able to add to our savings.
First, we are going to take our total monthly expenses and subtract that from our take-home pay. If, after all is said and done, we have at least 10% of our take-home pay left to put into a savings account, then we are doing a good job budgeting. We can just keep doing what we are doing.
However, if we wind up with less than 10% of our pay, it’s time to make some adjustments to our budget.
So, for example, let’s imagine that our take-home pay is $3,125. We spend $1,200 a month on needs and $600 on wants. Once all of our expenses are paid for, we are left with $325 that we can save on a monthly basis. In this scenario, there’s no need to change our spending habits. However, if we take home $3,125 and spend $3,125 a month, we’ll have to make some changes.
5. Adjust spending
If we find that we are in a position where there is no money left over after our expenses are paid, we’ll need to find ways to cut back on spending so that we can put some money into our savings account each month.
The first thing we will want to examine is our ‘wants’ expenses. We want to look at what costs we can lower or completely do without and will have the least impact upon us. For example, rather than spending $200 a month eating out, why not make some delicious meals at home and potentially have an additional $150 to save? It might take some getting used to, but we will survive without restaurant meals.
If reducing or eliminating our non-essential costs still isn’t giving us enough to save, we then have to consider changes that are a bit more drastic. That means thinking about finding lower-cost alternatives to essential expenses. Instead of driving our higher-end car, it will help to trade it in for a vehicle that carries a lower monthly expense. It may not be our first choice, but we will still be able to get where we need to go. The same thing goes for our living quarters. It may mean a smaller space, but it will allow you to start building up our savings.
6. Create an emergency fund
Now that our budget has been tweaked and we have freed up funds to begin saving, we should start an emergency fund. Unfortunately, life sometimes throws us curve-balls. We never know when it may be necessary to go for a period of time without working, but with some preparation, we can keep our heads above water should we have to go without income for a while.
For those of us that own homes or have dependants, our emergency fund should have enough in it to pay for six to nine months of living expenses. If we aren’t homeowners and we don’t have children, saving three to six months’ worth of living expenses is a good goal. We also want to ensure that once our account is funded, the money is in a safe location and one that can be accessed, such as a savings account.
7. Pay off short-term debts
The next step is to do away with short-term debts, like our credit card bills. For most of us, it’s not realistic to think that we can pay off long-term debts such as student loans or mortgages any time soon. However, our monthly savings can be used to chip away at our credit card balance. Paying off the short-term debt quickly will minimize the amount of money we waste paying interest charges.
8. Establish a retirement fund
Once our credit card debt is taken care of, we are going to start a retirement account. The earlier we start, the better. This will give the money time to build up. If employed, we should look into whether the company we work for offers a 401 (k) / super fund plan. If it doesn’t or we are self-employed, we should think about starting an IRA (individual retirement account) or superannuation fund (for those in Australia).
9. Set aside funds to meet short-term goals
Saving for a time far into the future rather than working towards short-term objectives may appear to be backwards at first.
However, since the ultimate goal is to have enough money to live off of after retirement, waiting will limit the amount of money we amass over time. That could put us at risk of not being to pay our expenses as we age and are no longer working.
Here’s a scenario to illustrate my point. Let’s assume our plan is to retire at age 65. At age 30 we begin putting $200 monthly into a retirement account. A reasonable average return rate for a stock-heavy portfolio could be around 8% and if that is the case, by age 65 we would have more than $413,000. Now let’s saw we waited until we were 40. Saving the same $200 monthly, by age 65 we will have less than half of what we would have saved 10 years earlier, around $175,000.
We can now see why looking towards the distant future rather than focusing first on our short-term goals is so important. That being said, once we establish a savings routine for retirement, any surplus money can be saved for our short term objectives such as purchasing a new home.
10. Invest remaining funds
At this point we have taken care of our emergency fund, paid off short-term debt, created a retirement savings account and, on top of it all began saving for that new house. Is there something else we should save for?
My answer to that is a resounding yes.
I think it is safe to say that there are always expenses that pop up where we could use a little extra cash. Perhaps it is time to take a much-needed vacation or we’ve been meaning to replace that worn-out sofa. Once that has been taken care of, the best thing to do with any remaining funds is to invest it.
Plan to invest funds that you don’t anticipate needing any time soon.
Once invested, we are going to want to leave that cash alone because historically, the stock market grows over time. Pulling out our money sooner than a year or two could leave us with less money than when we started. If an investment loses value, we need to give it enough time to recover. However, if all of our savings objectives have been met and we have the time to wait the market out, it is a smart move to let our money work for us and begin accumulating.
So, we see that saving money does require a bit of planning, thought, hard work and discipline. However, for those of us willing to stick to it, it will set us on the road towards financial freedom for the long-term.