Editor’s note: This article was first published in July 2012, during the European debt crisis; its remarks on austerity being demanded of governments and on former middle and high earners now being indebted reflect that moment.
It seems obvious that the ideal percentage of our income to save would be “the more, the better”. Even so, it’s good to set an exact minimum percentage so we don’t fall into the “I can’t this month; next month I’ll put away twice as much” trap. Any financial adviser would tell us the ideal savings rate is 10% or 20% of our income.
If we set that minimum percentage and force ourselves to save it, our own psychology will keep us from some unnecessary spending over the month. What should we do in a month when our income multiplies? The answer is simple: we shouldn’t spend more just because we can afford to that month. Quite the opposite: we should raise our savings rate or put all the extra money into our savings account. Why do this?
The word austerity is very much in fashion. It’s what is demanded of governments in times of crisis, when the truth is they should have been austere much earlier. As the saying goes, being austere when we can afford to spend (voluntary austerity) spares us from being austere out of necessity later on (forced austerity).
We start from the premise that, for many people, saving today is a pipe dream, since they can barely keep up with the debts they already have. Even so, you can always turn to some of our tips for getting your personal finances back in shape.
In the same way, we understand these percentages as applying to low incomes too, since people tend to think that middle and high earners can spend more because they earn more. That way of thinking is exactly what has pushed many former middle and high earners into the ranks of the “indebted earners” today.
First of all, we need what is known as an emergency fund. This fund should be kept in a liquid account and used only for extreme situations, such as losing your job or emergencies of any kind. It should be an amount of money that would let us get by for 3–6 months without any income. Since people who have money invested sometimes have to pull it out to cover unexpected expenses, this fund means not having to make that kind of decision, because cashing in an investment can mean a penalty (in the case of fixed income) or selling at a loss (in the case of equities).
To build the emergency fund faster, we can fall back on the old savings tricks, which will also help us increase how much we save:
- Open an interest-bearing savings account.
- Empty your loose change, the small coins, into a jar every night.
- Keep an eye out for discount coupons on everyday essentials.
- Cut down on or give up habits such as drinking and smoking.
- Look into some of the ways to earn extra money.
- Postpone your holidays, switch to a closer and cheaper destination, or cancel them.
- Watch those small daily expenses we don’t pay attention to.
- If you like to keep up with the latest technology, fine, but don’t be among the first to try the newest model: before long you’ll be able to buy it at a hefty discount.
- If you were planning to buy another vehicle, ask yourself a few questions: Is it absolutely necessary? Does my current vehicle run properly without repair bills?
- And so on.
In short, it takes considerable effort, but that effort should follow a plan that is as well defined as possible, with clear, concrete numbers. We need to apply business economics to household finances, since in the end both are based on income, expenses and profit.
The next steps would be to get the most out of our savings, whether in fixed income or equities, depending on our risk profile and how much we know about investing. But the essential thing to start with is the “raw material”: your first savings.
Further reading
Featured image: Billjones94, CC BY-SA 4.0, via Wikimedia Commons.
