My last post provided some tips on how to determine your upcoming expenses, specifically by reviewing the five key areas where those larger, non-recurring expenses tend to come from. Remember that this is an ongoing process and is never “complete,” as life is always changing and so will your financial and personal circumstances within it. At the same time, once you have committed yourself to a consistent budget and you have concretely thought ahead on what your upcoming big expenses will be, you should also take the time to sit down and lay out your savings goals.
“Do not save what is left after spending, but spend what is left after saving” – Warren Buffet
I think this quote really demonstrates how backwards our financial priorities often are (myself included). We get to a point where we’re so focused on spending the money we receive, whether we want to or need to, that saving becomes an afterthought. With this mindset, you end up setting aside far less than if you adopted a savings-first approach. That might be your default and you might even feel like there’s no other way, but the point of improving your financial wellbeing is learning how to do things a better way, not just the same things a different way.
Now, once you decide that you are going to prioritize saving, how do you do it? How much do you save each month? How much do you save in total?
As is typical, the answer is highly relative based on your own situation. There is no one-size-fits-all answer to these questions, but many before me have laid forth some basic guidance that should be able to lead you in the right direction.
The Steps to Success
I reference Dave Ramsey’s 7 Baby Steps a lot not only because they’re simple but because they work. The guidance in them has withstood the test of time and nearly ever account you’ll ever hear of someone who grew their own financial success followed many of these same steps, if not all of them, in this exact order.
Just to re-state them, here are the 7 Baby Steps:
- Save $1,000 for your starter emergency fund.
- Pay off all debt (except the house) using the debt snowball.
- Save 3-6 months of expenses in a fully funded emergency fund.
- Invest 15% of your household income in retirement.
- Save for your children’s college fund.
- Pay off your home early.
- Build wealth and give.
Notice the word “save” appears directly in 3 of these 7 Steps, including the first one. And the other 4 steps require saving beforehand in order to accomplish them. Saving is the absolute foundation of this journey, and I cannot stress enough how important of a skill it is to learn and develop over time and as your life changes.
Why $1,000?
$1,000 might seem like nothing compared with all of your expenses, but if you’ve never had that amount of money set aside for true emergencies before, it comes first for a reason. Keep in mind that over half of Americans report they cannot afford a $1,000 emergency expense in cash, so this is certainly not as meaningless of a goal as it might initially sound. Look at what you have right now. How much is in your bank account that you haven’t set aside for anything in particular? How much cash is in your wallet? Now, look at your monthly budget. How much are you able to save currently? Is there any way you can raise it? (The answer to this last question is “yes,” in nearly all cases, whether you believe it or not).
You might already be at $1,000 in emergency savings. If so, that’s great! You are doing better than you probably think. If not, try to get there as soon as you can. This sum of money won’t solve all your problems by any means, but it will give you peace of mind and finally get you to a point you’ve never reached before. Don’t stop reaching for it. If it’s possible for anyone, it’s possible for you.
Once you reach the $1,000-mark, Step 2 is to pay off all your debts with the exception of your home mortgage. You’ll hear a lot of different perspectives in the world of finance in terms of how to handle debt. Dave Ramsey and others like him will tell you to pay your debts as soon as possible, while others might encourage you to make minimum payments only and to hit other goals first before paying off your debts in full. For the most part, I agree with the philosophy of Dave Ramsey on this. When you sit down and calculate the amount of money you are accruing in interest on the loans you owe right now, it’s very possible that that amount is higher than what you are able to save monthly. Let’s take an example:
The Life of Maia
Let’s say Maia works as a payroll specialist and earns about $3,200 per month after taxes from her job. In her case, she has developed a budget and calculated her monthly bills totaling at about $2,900, which only leaves about $300 each month for her to save. $300 is a good amount to set aside, especially if she can be consistent with it. However, let’s also suppose part of that $2,900 is making minimum payments on the following debts as well:
- Student loans: $24,000 at 4.5% interest ($90/month)
- Car loan: $13,450 at 6.2% interest ($69/month)
- Credit cards: $1,340 at 22% interest ($294/month)
Just based on these current debt balances and their associated rates, Maia is being charged approximately $450 this month in interest. Yes, if she makes minimum payments monthly on all of these, both the balance and interest payments will both steadily decrease, and she could continue to save $300 simultaneously while doing so. However, one of the arguments for paying off all non-mortgage debt earlier rather than later is that the interest she is accruing month over month is canceling out Maia’s hard-earned savings. In order to build up savings that are not weighed down by additional factors, she ought to prioritize paying off these debts by sending the extra $300 every month towards those balances instead of keeping them in her savings account. By doing so, she will be debt-free quicker, which is the ideal state to be in if you want to truly maximize your savings potential.
In my own opinion, one of the biggest reasons to try to eliminate debt early is psychological, not purely mathematical. Escaping from that burden after years, even decades, of dealing with it can feel much more liberating that many imagine it to be. If you’ve never been debt-free before, I highly encourage you to research testimonies of people who finally got to that place after so long. Their words will speak volume. That boost can also go a long way in improving your overall wellbeing, which makes it easier to achieve more success in the future.
The Debt-Free State
Once you are free of debt (again, with the possible exception of a mortgage in this case), you are much more prepared to save than if you still owed money. The hundreds of dollars you were shelling out every single month to pay off your car or credit card balance can now be placed safely in your savings account. You will rest much easier now, knowing that the money there was earned by you and belongs solely to you as well. At this point you can really get a jumpstart on saving for whatever expenses you still expect to come your way.
If you are finally debt-free, it would be best to do everything in your power to remain that way. Admittedly, that’s not always possible. Life factors are changing constantly and just because you can afford everything you need without borrowing today doesn’t mean that will always be the case. Regardless, try to do your best to save for the expenses you do foresee coming. How much do you expect you’ll need when you get back to school? How much is that new car you’re looking at going to cost? Even for these more expensive purchases where paying 100% cash for them seems like a fever dream, the more you’re able to save up for a down payment in advance means less debt for you, which means less money you will end up paying in the long run. It’s in your best interest (no pun intended) to calculate those total costs now and work your way towards them, while you can.
That’s all for now. Peace!
