Saving-How to Be Wealthy-The ABC’s of Building Wealth-Part 4

The following post is part 4 in a 4 part series:
“How to Be Wealthy: The ABC’s of Building Wealth.“
Part 4 (this post) is about saving and how saving can help you build wealth.

“I don’t want to be saving.”

I know many people who don’t believe in saving money for the future. It’s as though they assume because they don’t WANT to be saving money for the future, they won’t NEED to have money in savings for the future.

Don’t believe me? Watch the Jerry Seinfeld clip below and you’ll see one ridiculous (albeit humorous!) example of what I mean!

 

Unfortunately, Mr. Seinfeld isn’t alone.

A long time ago, during my first year or so of college, I used to have the same problem. To me, the idea of saving money for the future was like going to the dentist for a root canal–OUCH!

Oh, we live and we learn though, don’t we?

Hopefully, after you finish reading this post, you’ll not only understand what you should be saving money for and how much you should be saving, but you’ll also see that saving money for the future isn’t as bad as you think it will be!

1. For what expenses should you be saving?

Essentially, there are two types of expenses you need to be saving for:

A. Saving for known expenses

These are “normal” expenses that happen only a few times a year (or lifetime). While the exact amounts might not be known, the fact that you will likely have most, if not all, of these expenses at some point IS known.

Think car insurance, Christmas gifts, home and vehicle maintenance, retirement (or “rehirement” as I like to call it), children’s college, etc.

B. Saving for unknown expenses

If you have a pulse and are reading this statement, at some point, there WILL be unknown expenses that pop up in your life (think car breakdowns, medical emergencies, etc.).

When will they happen? Only God knows.

But, rest assured, they WILL happen at some point. It’s called LIFE!

The bottom line is this:

You need to be saving for both known and unknown expenses, and if you’re not already saving, you need to start saving NOW!

2. How much should you be saving?

So, how much is enough when it comes to saving? Well, that all depends on what you are saving for.

A. Everyday Savings

Some people don’t even call this savings. I do, however, because it’s money that needs to be “saved” so you have it when the expenses come due throughout the year.

Some of these might be harder to estimate, like auto and home maintenance, but the majority of these expenses are known in advance.

Take car insurance for example.

Many people pay this expense monthly or quarterly; however, most insurance companies will give you a discount if you pay your premiums in one lump sum.

By saving up for and paying for that expense in a lump sum, you’ll knock out two birds with one stone…you’ll have the money saved and ready for when the bill comes due AND you’ll get a discount by paying it up front.

Can you believe it? I should be charging for this stuff!

B. “Mini” Emergency Savings

Your next savings priority should be to accumulate what I like to call a “mini” emergency fund. This will likely be somewhere between $500-$2,500 or so, depending upon your insurance deductibles and personal situation.

The reason this is an important first step is because if you have high interest debt (i.e. credit card, payday loan, etc.) that you are trying to pay off and something crazy happens (i.e. car breaks down, hail storm damages the roof, etc.), you need to be able to pay for this without going into more debt!

Hence, the “mini” emergency fund.

C. “Regular” Emergency Savings

Before you start socking away money into your “regular” emergency fund, you should try to have any high interest debt paid off (i.e. credit cards, auto loans, some student loans, etc.).

There are some exceptions to this rule, however, such as a match on any retirement savings through work, so you’ll want to talk to an independent, fee-only financial advisor to discuss your individual situation.

Once your high interest rate debt is paid off though, you’re ready to tackle this level of savings.

The old rule of thumb used to be to have 3-6 months of living expenses in savings (notice I said expenses, NOT income-big difference!).

Then the dot-com bubble happened…then the 2008-2009 financial crisis…then…well you get the picture.

At a minimum, you should aim to have at least enough money to cover your expenses during the elimination period on your disability insurance (and if you’re working, you should have some form of disability insurance!)

Why?

Because if you are injured and can’t work, typically there is a waiting period (i.e. elimination period) before you can start collecting benefits on your disability policy. You’ll need money to cover your monthly expenses during that time period, hence, my preceding recommendation.

I think for most people 3-6 months of living expenses is a good starting point, but the eventual goal would be 6-12 months of living expenses, or even more in some cases.

The less secure or consistent your income or job, the higher the recommended amount.

D. Long-Term Savings

Retirement savings, college, buying a house, starting a business–these all fit into the category of long-term savings.

A lot of how much you need to save for these expenses depends on your income, goals, etc. but a good starting point would be somewhere around 10-20% of your income.

Don’t worry though. You don’t necessarily have to start that high. Feel free to start small, maybe saving 3-4% of your income initially. Then, each month, increase that amount by 1% until you eventually reach your desired savings percentage.

With that said, there’s no turkey like cold turkey when it comes to cutting your spending and increasing your savings. So, if you want to skip the tricycle and hop right on the ‘big kid bike’ of saving money, be my guest!

Again, you really need to talk to an independent, fee-only financial advisor to get a better handle on how much you need to save to accomplish your goals, but these four categories should give you a decent starting point.

What’s an elephant have to do with saving for the future?

I mentioned at the beginning of this post that saving money feels like a daunting task for many people.

As we’ve seen, however, saving money for the future isn’t as bad as it seems. In fact, saving money is much like the following anecdote:

A Kung Fu teacher wanted to test the critical thinking skills of his young pupil and decided to pose a riddle to the pupil.

“How do you eat an elephant?” the Kung Fu teacher asked.

The pupil thought long and hard, but could not come up with an answer.

Realizing the pupil was having trouble, the Kung Fu teacher finally replied, “You eat an elephant just like you eat anything else…one bite at a time.

If you can learn to take things “one bite at a time,” then saving for the future will not be as difficult as it first seems.

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