Pardon the title but it’s not an exaggeration. Many people make personal finance extremely complicated and tough to follow. They create spreadsheets, make calculators, long lists of do’s and don’ts, rules after rules, tips after tips, for better personal finance. And though some of these tools and tricks are helpful, and you must implement them if you find yourself making those mistakes, personal finance is a lock and there is but one key to it.
And that key is… savings.
Not again, you might think. Why does everyone keep asking me to save? It sounds so boring, doesn’t it? What if I just die tomorrow and all my money is left behind in my bank account? You might retort. And I couldn’t disagree with you.
Life is unpredictable and anything can happen anytime. People drop dead randomly- they are fine one morning and you get the news that they are gone the next night. But if you live everyday like it’s your last, you would be wrong every time except once and each day you wake up is one more day you need to worry about.
Personal finance hinges on the hope that you live long enough to see your grandchildren (or whatever other way you like to imagine your distant future). And it aims at making that future good and easy. It doesn’t even have to be that distant. With some smart choices, you can very well make your very near future worry-free.
But for all your plans to work, you MUST save.
And this is true for everyone, no matter their current financial condition- from a janitor to a rock star. Even though you might think you have a lot and you don’t really need to save, beware. There are hundreds of very rich people who went broke very quickly.
But why is saving so important?
Because you can invest only what you save.
Investing is the bedrock to financial freedom. Investing is the only way you can make money work for you, so that you make money even while you sleep peacefully. Investing is what will help you to build wealth using the power of compounding. But you will not be able to invest if you don’t have money to invest. And how will you get money to invest?
By saving, of course.
You cannot invest what you spend.
The money you spend in eating out or getting uber rides cannot be used for investing because it’s gone forever. So is the money you spend on buying liabilities like cars and mobile phones, clothes and shoes. You may sell it someday in the future but since they are liabilities, they would pay you back only a tiny fraction at the end. And you would most probably use them to buy more liabilities.
Does that mean you should give up spending at all and live like a monk? Honestly, it’s not that bad an idea.
But, of course, it isn’t possible for most people. Besides, being overly miser with money may create a bad relationship with money itself. Don’t be a hoarder, but don’t be a spendthrift either. It is important to create a sustainable lifestyle which is not only enjoyable in the present but one that also secures your future.
Remember, personal finance is a lot like getting fit. You can take on one of those unsustainable diets where you starve yourself and lose a lot of weight early on but then you rebound and end up overeating and get bigger than before OR you can choose a sustainable lifestyle approach where you change your habits and create a life-long commitment to fitness. You won’t get abs in a month but once they do show up, they won’t leave you easily.
How should you save then?
Most people like to think of savings as what remains after spending. This also creates a major hurdle for many people as they have nothing left after spending their hearts out. I like to think of it the other way around.
I like to think of spending as what is left after savings, meaning you save first and spend what is left. This approach has multiple benefits:
Because you take out you savings first, you will have no excuses to not save.
It will help you stay consistent with savings.
You don’t have to worry a lot about budgeting or analyzing hundreds of expenses to save some money.
You will be able to spend the rest of your money guilty-free
Pro-tip: Automate this process of taking out a part of your income as savings. This will help you prevent you from yourself. Create a separate bank account to park your savings till you decide on how and where you wish to invest it in.
How do you save more?
It is one thing to write “Save first, spend later” but it is a completely different thing to do this in action. Most people don’t do it because they can’t. As soon as money lands in their account, it goes into paying many of their EMIs and the rest is often consumed in maintaining their unsustainably extravagant lifestyles. Sometimes, they strive and fight and end up saving a little bit. But their roof ends up leaking or someone breaks into their car, and all that money is drained into this unforeseen expense.
Hence, if you are just beginning to save or actually trying to create a sustainable process of saving, do these things:
1. Check how much you are saving now:
Look at your income and what you are left with every month
The percentage of your net income (in-hand income after deducting taxes) that you save is known as your “savings rate”. Calculate your average saving rate for a few months.
2. Set a goal:
Now that you know how much you are saving now, make a goal on how much you wish to save in the future
I would suggest you try to atleast double it if your current rate is less than 25%. If it is more than 25%, try to increase it by 10% in the next three months.
Remember, there is no right answer for this. The more you save, the better. So don’t be frugal in saving.
3. Look at your expenses, really look at them:
If you aren’t saving a lot, it is because you are spending it.
Look at all places you are spending your money, even the small transactions. Make a note of them.
Divide your expenses between discretionary and non-discretionary expenses
Non-discretionary means necessary expenses like groceries, utility bills, rent, EMIs, insurance payments, school fees, transport costs, etc which you have to do to survive. It is generally difficult to reduce these but try to be practical. You can always opt for a train or shared taxi ride instead of private Uber rides or using your own car. You can pay off expensive debt quickly and avoid extra charges. Click here to find ways to reduce your necessary costs.
Discretionary expenses are those which you don’t need to do, but which you like to do. This is often sold to financially unaware plebeians as “lifestyle” and end up growing as the income of people grows. These include expenses like eating out, going to the movies, splurging on branded clothes, watches, bags and shoes, unwanted subscriptions, vacations, parties, etc. Take these out as abundantly as you can. Don’t be shy.
Pro-tip: Look for emotional expenses. Many people go on shopping binges when they feel bad about themselves. Limiting such emotional expenses can be very helpful in the long run.
4. Calculate the shortfall and create a plan:
You now know how much you spend, how much you save, and how much you wish to save.
Calculate the shortfall in savings.
Direct your deleted expenses towards savings.
In the off chance you don’t have a lot of expenses you can remove, but still aren’t able to save, then it is time to either increase your primary income (Ask your boss for a promotion, duh) or start an additional source of income. You can do this by starting a side hustle. It can be anything you like or are good at. It may take some time but it will work if you are consistent. (I have listed 12 easy side hustles you can start today here)
5. Save first every month:
Direct your deleted expenses or additional income towards savings.
Save first, spend later
Automate the process to do it consistently.
6. Invest:
Duh!
Savings is of no use if it just stays in your house as cash or in your savings account giving you a paltry rate of return lesser than inflation. Investing is what you are saving the money for. (Read this if you are still not sure why you MUST invest)
You don’t have to start buying stocks directly if you don’t know how to start.
Read up, get knowledgeable. But in the meantime, start putting your money in an index fund atleast. (Read this to know why index funds are awesome for beginners)
7. Create an emergency fund:
To avoid a situation where your savings or investments get used up in an unforeseen situation, create an emergency fund.
This will help you continue your investments while you deal with the unforeseen trouble. Read our detailed article here on how to create an emergency fund.
Bottom line:
You must invest to make money work for you.
But you can't invest what you spend. You can only invest what you save.
Start saving
Increase your savings by cutting out unnecessary expenses or work towards increasing your income
Don't keep your saved money stashed as cash. Invest it.
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