How To Increase Your Savings
It has been said that to become a
millionaire in 30 to 40 years you just need to save $5 a day. This
advice overlooks two main factors in savings: the amount of
money you actually need for retirement and the amount of
time
you
have
to
save
that money.
Before you start counting on becoming a millionaire, consider the
following:
-
Determine how much you need
to save.
It may sound obvious, however, it is often
overlooked.
There are several problems with just using an arbitrary
number (e.g. saving $5/day):
1) Investment Return - Most of these millionaire
projections use a 10% to 12% rate of return on your investment,
which may be reasonable if you only
invest
in
equities
with
low investment
management fees. However,
most people may want to diversify their investments
into other vehicles (e.g. in bonds) which typically have smaller
returns. The
difference in assuming a 10% return and an 8% return based
on saving a flat amount each year would result in a
30% lower balance by the end of
the
30th year. It is important to understand the impact of
investment
return on savings over time.
2) Inflation - The value of $1 million in 30 years
is equivalent to approximately $400,000 in today's dollars
and
$300,000 in
40 years (assuming 3% inflation).
3) Retirement Needs - Before becoming fixated on
a goal of $1 million, realize that some people may need
$500,000 (or less) for retirement while others may need
$1 million
to
$5 million
depending
on
their age, expenses,
and company's pension fund. You
need to understand what you need to replace
your current income in retirement.
This does not mean that you should give up on the idea of being
a millionaire. It does mean that you should determine
how much you actually need (e.g., for retirement) and plan your
savings accordingly.
- Make your goals more tangible.
If
you say that you want to increase
savings, what is this statement? It
is a goal. A goal has a
better likelihood of being met
if it is real and
tangible. If
your goal is to lose
100 pounds. That is a
good
goal. Yet,
your goal will be more attainable
when it becomes more vivid and
impactful. In other words,
what is the real reason
for your
goal? A more vivid goal
is "I want to lose weight in
order to decrease my blood pressure
to 120/80, and live
long enough to see my grandchildren
graduate from college." This
is not just about weight loss;
it is about being healthier
by having a better blood pressure. It
also becomes a desire by wanting
to see your grandchildren graduate
from college. So
when you go for that piece of
candy,
you
picture
yourself at your
grandchildren college commencement
and have more motivation
to avoid the piece of candy versus
just wanting to lose 100 pounds. Desire
creates energy. Energy
produces results.
If you are saving for a vacation, then picture yourself at
your vacation destination. If it is for retirement,
then picture yourself enjoying your retirement, playing
golf or sitting on a beach with a drink and a book. You
can make posters of your goals and desires using pictures from
magazines. Use these posters to remind you of your goals
and motivate you to save.
- Determine how much of an increase in savings you need.
If you need just a minor adjustment, then the $5 a day proposal
may be just what you need. Yet, if you need more than a minor
adjustment, then saving $5 a day may not be
enough. Determine
how much a month or year you need to save to meet your goals.
- Review your budget.
Challenge yourself on all your spending categories, looking for
ways to cut expenses. This
goes from housing and vacations to the daily cup of coffee. You
may have to give up more than a cup of coffee to meet your savings
goal. You may actually need to change
your lifestyle (vacations, cars, or home), if your goal is to
save $15 or more a day.
- Write down specific changes to your budget.
Write down exactly what your game plan is and keep
it somewhere that you will see it weekly to review
how you are doing.
Create intermediate goals. If you have a long-term plan
for retirement, break it up into steps for each of the next 5 to
10 years. Having a single long-term goal may be too overwhelming. It
is easier to break it up into smaller amounts.
- Celebrate your successes.
When you are meeting or exceeding your goals, celebrate the successes. Have
fun with the process, and acknowledge your hard work.
Food for Thought - other saving recommendations that do
not work
"When you get a raise, save half and spend half."
Let's say
you get a 5% raise. If you follow the advice above, then you
would spend 2.5% on an upgraded lifestyle and save
2.5%. Yet,
what about inflation? Really,
the raise was only 2%, assuming
3% inflation. So,
if you increased your spending by 2.5%, you
would find yourself quickly going over budget,
unless you cut back on
other areas.
In today's environment,
many employees are getting raises equal
to
inflation
or less. Thus,
there is nothing additional to save. In fact, you may
need to cut other areas of your budget if your salary does not
keep up with
inflation.
Alternative Recommendations:
1) Save part of the increase above
inflation (in the above example, 5% raise - 3% inflation = 2% to
save and/or spend -- save part and spend part).
2) Increase your
savings annually (e.g., 1% annually). For
example, if your savings goal is 10% and you are saving 5% a year,
increase your
savings by 1% a year. Finding ways to save 1% a year is more
manageable than a dramatic 5% all at once (especially if you have
large fixed payments like a mortgage and/or car
loans). This
will create a gradual transition to
a more manageable lifestyle that will allow you to adjust your
budget over time, for example, when you buy your next car.
"Pay yourself first."
This is becoming a popular tool for savings. They
say that by putting your target savings into a 401(k) fund or
automatic investment fund, then you will meet your savings goal because
you are not tempted to spend the money that you do not have due to
being automatically invested. The premise in this advise
is that people have a tendency to spend what they have. "Pay
yourself first" does not address this behavior but tries to work
around one's spending problems. What it fails to account for
is timing of certain expenses. Assume that in December buys
holiday presents and is forced to repair the furnace that broke down. With
these additional expenses beyond their normal spending budget for
the month, they are forced to tap into their emergency fund, for
items that are not really emergencies . Appliances will
break down and should be budgeted for instead of being an emergency. What
happens if this person lost their job in February before being able
to replenish the emergency fund?
"Pay yourself first" can be beneficial in saving money, however,
it does not replace a budget. Many have succeeded with this
approach. Others that got hit with unplanned purchases (e.g.,
appliance repairs) followed by real emergencies may not have succeeded. To
illustrate this, I wonder how many people in the North did not sit
down and plan for the higher home heating costs for the winter of
2005/2006. In January and February they are stuck with
needing to pay bills may have needed to tap into the emergency
fund because they
did
not
change
their spending habits soon enough. Yet,
for those with a budget, these discussions are made in September
and October about how they need to allocate more to heating costs
and can discuss where to cut other expenses to meet their budget. These
families who plan maintain their emergency funds for true emergencies
instead of using it for unavoidable purchases that were not planned
for.
Alternative Recommendation: Having a budget
about how much you will spend and save can not be eliminated. You
can save automatically or by transferring
the money
yourself
each month. There is nothing wrong with pay yourself first
as long as you retain the power over your budget rather than the
forced savings controlling you. I say this because you
may find a way to save even more by going through the budget process
first. In
addition, if you have additional income in a month (e.g., unexpected
bonus), you will be more likely to consciously decided whether to
spend it
or
save it. Where
under pay yourself first, unconscious
spending has not been addressed, so one is more likely to spend
the extra income automatically.
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