What is a good rule of thumb when it comes to saving money?
Last updated on June 30, 2020
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You know you have to save money. If you don't, you will never have it wonderful feeling of financial freedom. You could work until the day you die. And who, with a clear mind, would enjoy this view?
According to statistics from the US Bureau of Economic Analysis, People in the United States save less than 8% of their disposable income on average. That won't give you a comfortable retirement. As a rule of thumb, you should save between 10% and 15% of your retirement income. And that doesn't include saving for your other financial goals.
Of course, this is not the only saving rule. In this article you will learn the seven most important rules of thumb for saving money.
To save, you have to budget
The more you save, the richer you get. Of course you have to live too. And that means spending money on necessities and lifestyle. The secret to saving more is to budget effectively. This will help you avoid spending more, reduce debt, and find the money to save more.
Budgeting is a habit that needs to be learned. The first step is too Make a budget from scratch. We recommend following these seven steps to focus your budget on your financial goals:
- Step 1: set your financial goals.
- Step 2: Predict your income based on your income for the past six months.
- Step 3: Predict your spending (required and at your own discretion) based on your spending over the past six months.
- Step 4: Calculate your savings rate (minimum savings rate is income minus all expenses, maximum is income minus necessary expenses).
- Step 5: Evaluate your financial goals based on your expenses.
- Step 6: track your savings every month.
- Step 7: Track your net worth regularly to monitor progress toward your financial goals.
No matter how good your intentions are, it can be difficult to stick to a budget. It's easy to be seduced by retailers' tricks and spend money spontaneously. You need discipline to stay on budget. Always remember why you set your budget before making a spending decision. Then:
- Think about the real cost
- Think about it Opportunity costs (What could you have done with this money?)
- Think about the hidden costs (what the money you will spend may be worth in the future
Another difficulty is that you need to track your spending in order to budget successfully. Fortunately, there are many tools and Apps that help you budgetTrack your expenses and accelerate your goals. We have described some of them in detail in our article "10 best budgeting apps for personal finance". These include:
- YNAB (you need a budget) This is a great tool to connect your bank accounts and see your transactions in real time, and get suggestions to help you get rid of debt.
- Mint, This notifies you when your bill payments are due, helps track investments, and syncs your financial information.
- Mvelopes, This is to help set goals to eliminate debt.
Our favorite tool for savers and investors Personal capital. This is a free app that will help you Track your expenses and target savings and investments. You can connect and track your long-term investments – like your 401 (k) – as well as yours Savings accounts, Credit cards, loans and mortgages.
The Personal Capital app is used for budgeting Help you understand how to spend money by categorizing your expenses. Keeping track of your net worth couldn't be easier – the calculation will be done for you.
Another cool feature is that Personal Capital offers a wide range of additional investment resources such as: B. Financial planning and investment reviews.
If you use these financial instruments to improve your budget, you can stick to our second rule of thumb.
What is a good percentage for savings? The 50/30/20 savings rule.
The saving rule 50/30/20 makes it easier to allocate your money. It simply means that you should assign the following to your earnings:
- 50% on the bare minimum (such as rent, utilities, food, etc.)
- 30% on discretionary expenses (such as entertainment and takeaway food)
- 20% for savings and investments
This rule relieves budgeting and balances your commitments and impulses with your financial goals. However, it doesn't take into account your income and the cost of living where you do it. 50% may not be enough if you have a modest salary but live in a high-cost place.
6 more rules of thumb that can help you save more
A rule of thumb is never enough. Because of your personal circumstances, you need to be a little bit smarter so that you can “bend” the rules a little to your liking. These six other financial rules of thumb will help you build the Flexibility in budgeting and savings that accelerates you in reaching your financial goals.
1. Maintain an emergency fund
Establishment and maintenance of an emergency fund of six months of your expenses for necessities. If you lose your job, this financial cushion gives you the time to find another suitable position instead of being forced to accept the first offer that comes to avoid losing your home.
This can be difficult to accomplish, especially if you start from scratch and have other priorities, e.g. B. Reduce debt and invest in your future in addition to the high daily cost of living. Adjust your own needs when saving an emergency fund by considering the following:
- Your income
- Access to other money
- Your monthly expenses
- How much could you reduce your expenses in a financial emergency
Remember that too Your emergency fund should be kept in an accessible account. This avoids penalties for withdrawals, even though you don't earn as much interest as if your money were tied up for a long time.
2. Pay off your credit card debt first
According to Debt.orgThe average American household owes $ 8,398 in credit card debt. This means that with one average interest rate of 16.97%The average American family pays around $ 1,425 in interest on their credit cards each year.
Credit card debt is the most expensive debt that most people have – and you should always pay off your most expensive debt first. You pay less interest and therefore have more money to pay off other debts faster.
3. Save 10% of your retirement income
This is a common rule of thumb for your retirement pot. There is a clear number for working and is easy to put into practice. Open a retirement account like a 401 (k) and set aside 10% of your income. You save tax efficiently and your employer can also make a contribution.
The problem with this rule is that it doesn't take into account how much you need when you retire, and it doesn't take into account when you want to retire. If you want to retire earlier, you need to save more. If you want to maintain a high and expensive standard of living, you need more money.
So it may be best to save at least 10%, but your retirement savings are also based on how big your retirement fund needs to be to pay for your desired retirement lifestyle. To do this, calculate today's cost and multiply it by 20. This number is used because it is assumed that your retired fund will grow by 4% or you can withdraw 4% each year for at least 20 years.
As soon as you have calculated the required fund size, you can Calculate how much you need to invest for your retirement (Read our post "How can investors make compound returns with a million dollars and retire?" to learn more.)
4. The 50/15/5 rule
This rule keeps things simple and is a variation of the 50/30/20 savings rule. You assign:
- 50% on essential expenses
- 15% for retirement investments
- 5% on short-term savings for your emergency fund
The other 30% is used for other expenses and savings. However, if your circumstances change over time, your priorities will change. A new home, a new marriage, and children will change your spending needs, and this could make it difficult Maintain financial discipline to keep this rule of thumb.
5. Pay first
Have you ever wondered why the government takes your tax money before you see a penny of your income? This way your money is guaranteed. You should do that too. Treat your savings pots like tax officials and pay first on the day you receive your paycheck.
After you have set your financial goals and budget, first make sure you have the money you know you need Saving towards your financial goals is set aside. You will soon get used to not having this money available, and this will help you resist the temptation to spend what you should save.
6. Reduce your expenses
Of all of our rules of thumb, this may be the most crucial. The lower your expenses, the more you can save. This can be easier than you think. Our contribution ‘How to drastically reduce expenses’ provides details on the seven most effective ways to reduce your monthly costs:
- Refinance your car or home loan
- Reduce the cost of your food
- Get a roommate
- Learn to make designer clothing too economical and to pass it on
- Disable luxury services
- Use a financial health app like Personal Capital
- Sell your car
If you can cut your spending by just $ 100 a month, pay off yourself first save the money IInstead you might be retiring as a millionaire. And guess what? Most people can cut their spending by more than $ 100 a month.
What is the typical relationship between time and interest rate?
The longer you save, the higher the interest rate you are likely to get. This is because the institution where you save has more time making money for yourself with your money.
The same relationship exists when you borrow money – the longer the loan term, the higher the interest rate you are likely to be charged. The scales are tipped against you when you borrow money and in your favor when you save.
There is a certain way to increase your savings, and that's too benefit from compound interest. Instead of taking your interest or dividends when they are paid out, you should reinvest them. You earn interest on the interest, and when the interest paid increases, your income increases. Here is the difference between compound interest:
- Let's say you invest $ 1,000 and get 5% interest every year for 20 years
- You will receive $ 1,000 interest without compounding
- With compounding, you get $ 1,653 interest – more than 60% more!
What is a good rule of thumb when it comes to saving money?
There is no single rule of thumb when saving. There are many. In order for them to be effective, you need to adapt them to your particular circumstances. It is important to take a comprehensive approach to budgeting and saving:
- Reduce debt
- Spend wisely
- Save more
Your efforts will be rewarded if you retire earlier and live a life of financial freedom where you can help others enjoy their lives equally.