Friday, June 24, 2011

I Should be Saving How Much?! by John D Buerger, CFP®

How much of your income should you be saving?
A common rule of thumb answer used to be that 10 percent of income should go into savings.
"But 10 percent of income is a lot!" is a common response. Saving that kind of money seems so daunting that most people don't even try, which is why the national savings rate ended up actually being negative in the mid-2000's. Today, consumers are spending less and saving more, but the national savings rate is still in the low single digits - well below the 8 to 10 percent rate in the 50's and 60's.
10 Percent Is Not Enough
Here's the real kicker: based on recently published research, the average savings rate really should be 16 to 20 percent of household income... not 10 percent.
Sixteen to 20 percent?! Ouch!
If 10 percent was so difficult that most Americans didn't even try, how likely is it that you will take a shot at 20 percent savings? It's almost too depressing to think about.
coinsMission Impossible
Hang with me for a few more minutes, though, and let's see if we can make a dent in this seemingly impossible 20 percent savings target.
As a Certified Financial Planner™, I've reviewed lots of client cases over the years. Since I believe true wealth is built out of cash flow management (not investment management), I have paid closest attention to the successes and failures of various savings strategies.
Here is what works:
Step #1: Trim the Fat

Almost everybody can identify 5 percent in cash flow savings just by paying attention to expense details. Use an online budget planner to chronicle every dollar that you spend.
When you see an expense you don't recognize or is surprising, you will have found an easy place to trim your expenses. Spending your money on that item obviously didn't register as much of an experience. Otherwise, you would have remembered it.
Step #2: Understand Value

Take a moment to think about the most important things in life to you. These are your values. For most people, top tier values include relationships, family and special experiences. They almost never include “stuff” (i.e. tangible items). Humans are hard-wired to be attracted to shiny new things, but that attraction doesn't last and the item is soon forgotten.
Here's an example: remember the new shirt you "had to have" back in 2002? Me neither. Same thing goes for most restaurant meals - they just aren't that special to remember.
In the grand scheme of things, the phrase, "He who dies with the most toys wins," is rarely what's going through the mind of a person on their death bed.
Step #3: Pay for Value
Every time you are faced with a spending decision, take a short pause to ask yourself, "Is having this really important to me? How important is it?"
Compare your answers to how important having something different that you would really treasure would be in your life. Understand that every dollar you spend on one thing is a dollar that cannot be spent on something else that you might value more.
Step #4: Shift Your Framework
The last trick is to change the perspective with which you view each purchase decision. Our tendency is to view expenses in comparison to our annual personal income: "I make $40,000 a year. This is a $20 purchase. Twenty bucks is nothing compared to $40,000, so the cost is insignificant." Or, "The cost is zero and I want it."
When your brain does the cost-benefit analysis - you end up making the purchase.
But what if you compared that $20 purchase decision to the money you REALLY have control over. For most people that "control income" ends up being $100-150 per week for everything including food, clothing expenses and entertainment - truly discretionary expenses. The rest of the money you spend each week is to pay taxes or fulfill previous obligations like rent or mortgage, utilities, loan payments and gas for your car.
Now that the $20 decision IS significant (compared to $100 you have to spend all week), you might be tempted to think twice about dropping the cash.
You Can Do This

Implementing each of these four steps can easily trim 10 to 15 percent of your current expenses without giving up anything that is really important to you. You're just spending less money on the stuff that doesn't matter anyway.
I have seen many cases where clients have actually been able to exceed the 20 percent savings rate target and in every case they have said they have never been happier.

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