Saving money is crucial for a few reasons. First, it enables you to buy investments and eventually reach financial independence – that is, the ability to live off your investment income. Second, only by saving can you create a financial cushion to protect yourself from life’s blows such as an unexpected medical bill or an unforeseen repair.
The Wrong Way to Save
Most people get saving wrong. They try to “budget” and then put aside whatever money is left in the end of the month. More often than not, that doesn’t work well.
Why is that happening? You see, there is a powerful law in place, which I call The Law of Matching Expenses:
No matter what your income is, your expenses will always find a way to catch up.
The Law of Matching Expenses means that no matter how hard you try, there will be very little money left to put aside in the end of the month – if any.
The only way to fool the law is to save in the beginning, not the end.
Pay Yourself First
Paying yourself first means that you set aside a percentage of all your income first thing after receiving it. Got a paycheck? Deposit 10% immediately in your savings account. Got a gift from an uncle? There goes 10% to your savings.
Paying yourself first is the opposite to paying other people first, e.g. your landlord, the phone company, the grocery store etc.
Basically, what you want to do is set money aside, and then forget about it as if it never existed.
To start saving, the exact percentage you set aside is not important. I save 10% but you can start with 1% and increase the percentage over time. What’s important is that you do it, and stick to the routine religiously.
Save Half of Your Income Increases
This tip will help you save even more:
Whenever your monthly income increases, direct 50% of the difference to your savings.
Here is how it works. Imagine that you are an employee and your salary is $5,000 per month. You set aside 10%, or $500, from each paycheck, which leaves you with $4,500 for your monthly expenses.
Now, you get a promotion and your salary becomes $6,000. Instead of assigning just 10% of the $1,000 difference to savings, you assign 50%, or $500. You have now doubled the amount you save every month (from $500 to $1,000) and your disposable income still went up from $4,500 to $5,000 monthly.
If you stick to this routine, you will eventually find yourself saving almost half of your income. Imagine how many great investments you will now be able to afford!
Protect the Money from Yourself
This is a bonus tip. As you set the money aside in the beginning of every month, make sure that it’s not easily accessible. As much as we want to believe in our willpower, it is human nature to tap the cash that’s just lying around.
Remember that your savings are untouchable and can only be spent on investments or in case of an emergency. (Actually, a good idea would be to keep emergency and investment money in two different accounts.)
What you want to do is put your savings money in a bank account that has no online banking or debit card attached. That way, you would have to physically go to the bank if you decide to withdraw, which will give you plenty of time to reconsider.
Here’s to your financial freedom, and remember to pay yourself first!