Financial advisors always talk about the importance of saving money. But why? And how? Here’s the primer seen through the lens of personal financial planning.
How does saving money contribute to your financial planning?
One of the awkward facts of life is that money comes into our lives in a different rhythm than we spend it. Saving helps resolve that awkwardness. Saving money is a means of moving personal wealth from a time or state when you have it (i.e. when you have reliable income and good health) to when you don’t (when income stops and/or you have a financial emergency). Think of your pool of savings as a reservoir helping to even out the incoming and outgoing flows of cash.
When is it best to start saving?
Start early. The earlier you start saving the less you have to save, as this eye popping graphic illustrates. Plus, as with any good habit, it’s easiest if you start out in life with the habit as a given.
How much should I save?
No one knows how much you need to save. Oh, ouch. That’s awkward. But true. How much you need to save depends on future interest rates, future investment returns, how much you’ll need later on, how long you will live, and how early you start saving. While you can’t resolve those uncertainties, here’s a reasonable path that successful savers frequently follow: When you are young, just save something from every dollar you earn. As you hit your stride in life, save 5% of earned income, then 10%, and keep going until you get to 20%. That’s a reasonable default path you can tweak for your individual circumstances, e.g. save more if you are saving for a down payment on a new home or building a cash reserve for an anticipated career disruption or if you started saving late.
What counts as savings?
Unfortunately, paying down credit card debt does not count as savings. Those are deferred payments for past consumption. Saving means putting money aside for a long-term purpose. Examples include:
What are good strategies for effective saving?
Pay yourself first. Few of us have money leftover at the end of the month—or time to figure out each month what amount is leftover for saving. So make transfers to savings automatic. And make them frequent. One of the secrets of successful personal financial management is that cumulative small steps in the right direction work, including e.g. a steady stream of automated savings. (By the way, a second core secret to personal cash flow management is to not look back. If you want to repair suboptimal spending and savings habits, look for the right best next step forward. Looking backward is not only a downer, it does not help. (See our three-part blog series on cash flow management for more detail.)
What do savvy savers know that other people don’t?
First, it can be hard to recognize savvy savers. They don’t talk about saving regularly and effectively, anymore than they talk about brushing their teeth every day. You have to notice them. Here are some hallmarks:
Savings is an important topic whenever financial advisors and their clients meet. Perhaps because saving is the inverse, the twin, the opposite of, the only real question in financial planning which, for all of us, is: How much can I safely spend?
To be in charge of your life, to find your way through to drama free daily finances, and to get money issues in the background where they belong, figure out where you are—and where you would like to be—on the saving/spending spectrum.
Savvy savers tend to be savvy spenders and vice versa.
Who in your life stands out for you as a savvy saver/spender?
Originally published: December 1, 2016