How to Build Savings
By Christine Schmidt
In January, we talked about the variety of ways to approach finances, particularly for Christians. While talking to people in my job as a financial professional, I saw that many clients fall into one of three main viewpoints:
Obsession with money and material things.
Liberally spending while neglectful of finances.
Indifference due to a process that is currently working.
As indicated last month, we are to be stewards with what we are given––taking care of whatever we have a responsibility towards––including our finances. No matter who we are or how much we make (hourly, salaried, or commissioned), we each have a responsibility to use these funds well. I briefly noted that there are several ways that our money is used: bills, savings, investments, protection, and charity. Bills are self-explanatory and necessary expenses, so the first of these we’ll dive into is savings.
Pay yourself first
To have savings, there must be money that is set aside for a later date. While one can put away money from bonuses and, occasionally, tax returns, there is a time-tested principle that helps build financial discipline while budgeting for the necessities called paying yourself first.
Paying yourself first means to set aside a portion of your income each month for your monetary goals and future as a designated bill. Just as you make sure to pay your necessary bills such as rent or your mortgage, paying yourself first means you treat yourself as one of those necessary bills, in order to make sure you have money for emergencies and to attain future goals.
How does paying yourself first work? It involves taking a percentage of your monthly income and designating it towards specific strategies and categories to accomplish your goals. Typically, professionals recommend utilizing a total of 20% of your income while living on the remaining 80% for your bills. The 20% to be saved for the future is further broken down into fourths (5% each) for the remaining categories mentioned in the last article: savings, investing, protection, and charity. In this article, however, we shall focus on the 5% used for savings. While many professionals recommend twenty percent of your monthly income, this percentage can be a target or a starting point depending on your current circumstances.
This principle helps to re-visualize savings (and, therefore, goals) as a bill to be paid, helping to target and accomplish healthy monetary habits and utilize money to its fullest potential. Similar to stewardship, which requires intentional responsibility, paying yourself first is meant to practice practical intentionality. Likewise, this method requires another concept compatible with stewardship: living below your means.
When discussing the different attitudes to money, one attitude typically has a harder time spending less than they earned: the neglectful. Being neglectful usually leads to overspending in my clients’ lives, since there is no responsibility taken to track how much money was being used. By budgeting and practicing the principles of living below their means and paying themselves first they were able to get back on track and develop a stewardship towards their money while achieving their goals!
Living below your means is an important part of peace of mind and goes hand in hand with paying yourself first. While it is critical to both plan for the future and enjoy the present, too much of one or the other can be detrimental. We will discuss the pitfalls of focusing too much on the future later in the article. Here, it is necessary to note that if one focuses too much on living extravagantly now, there may be no funds to pay the bills nor for emergencies or meeting future desires and needs. The concept of living below your means, however, is simple, and makes it easy to avoid the stressful consequences of overspending. Candidly put, living below your means is spending less than you earn in your income each month. While this is simple in theory, it can be hard in practice for some, especially when one becomes accustomed to a certain lifestyle. Yet by taking an honest look at one’s finances and habits, adjusting to spend less than you earn you sets yourself up for less stress and future success!
It is important to begin the practice of separating and designating funds to be set aside for particular goals, no matter the percentage of income, in order to develop good habits and increase financial confidence and, thus, preparedness for future circumstances. Below are a few steps to begin this process.
Step 1: Review your bills
To calculate how much to pay yourself monthly, begin by looking at your bills. Assess how much you need to live, the things that are musts for life. There are many different budgeting formats, and you can make one yourself, use an app, or find a spreadsheet online. Two good apps are Mint and YNAB. Mint has gotten consistently good reviews and is free. If you want to splurge about ten dollars and subscribe to an app, YNAB (or “You Need A Budget”) is excellent for implementing the techniques laid out in these articles. A straightforward, but excellent budget worksheet can be found on floridaliteracy.org. It does not matter what you use to budget, though, as long as it works well for you.
Two difficult things to budget out for bills are usually groceries and entertainment. While it may seem counterintuitive to include entertainment as a bill, call to mind the parable of the farmer who stored away his grain for the future only to die that very night––likewise, we should enjoy today while ensuring tomorrow’s stability. To factor groceries and entertainment in, try the envelope method or a similar method. The envelope method involves setting aside a fixed amount of cash per month in an envelope and not spending any more than what was initially allotted. What makes this method compatible with budgeting and paying yourself first is that it makes groceries and entertainment into bills that typically cost the same amount monthly––much like an internet bill or car insurance––allowing for easier calculations and disciplined spending habits. For a cashless method, try using a prepaid Visa gift card or low-limit bank credit card and paying it off in full each month.
Step 2: Pay yourself
Once the budget has been determined, look at how much is left over. Of the remaining amount, it is usually wise to use two thirds to set aside to pay yourself first. The remaining third is typically saved for things you may have accidentally not calculated correctly (you may have messed up, but not by that much!). You can rearrange as you like and, if need be, readjust how much is being allocated to some of the more discretionary bills, such as entertainment. As an example, say I am a single, young professional making $2,700 a month after taxes, and my monthly expenses add up to about $1800. I have $900 left after I pay all my necessary bills (including groceries and entertainment). I will set aside $600 to pay myself first, and $300 in case something was wrong with my budget, such as if I miscalculated my living expenses, or if there was a bill that was more than expected, such as electricity in the winter. Now, I will further divide the $600 into fourths, as the method instructs, divided among savings, investing, protection and charity; this would mean $150 would go to each category each month.
Step 3: Divide your savings between emergencies and goals
Now, we will focus solely on the money that goes into savings. Savings is an important use of money because of the goals it helps accomplish. Last month, I mentioned that we need to be stable in our finances in order to live well and help others––savings is the first step in achieving that stability. The basic ideology behind savings is that it is highly liquid (meaning that it is readily available whenever you need it) and, because of its liquid nature, it’s typically used for emergencies and short-term goals, wants, and needs.
While it is not common to think of savings as being divided into two further subcategories, it actually makes a lot of sense. These subcategories would be labeled emergencies and short-term goals/needs. Consider the following: things like getting new tires may seem like an emergency––you need them now to get to work!––but new tires are actually better categorized as a short-term need. When a car is bought, it is generally understood that, sooner or later, the tires may need to be replaced; thus, it is better to treat things like tires or oil changes as a short-term need. These short-term needs do not have to be stressful, since they can be generally prepared for ahead of time by utilizing the right strategy. Emergencies would be better categorized as things like your windshield breaking, a flight home for a funeral, or being laid off of work, since those situations are so unexpected, while things like presents and oil changes are better categorized as short-term needs / goals since we know that they are periodic expenses.
The account for short-term goals should be funded quickly because it is meant to be flexible as we spend it on things that occur sometime in the near future, such as birthday and Christmas presents, going home for a holiday or a weekend trip to visit friends, a shopping spree, or oil changes. Some other short-term goals can include more simple purchases like homegoods or clothing. Sometimes these goals can look a little different, depending on your lifestyle. For example, parents often buy their kids a new wardrobe for school, since they typically grow each year. This would still fall under a short-term need/goal since it is an expected future expense. A good way to figure out how to categorize various expenses would be to test them, seeing if they’re a want, more accurately categorized as a short-term goal, or a need, which is then further categorized as either expected (short term goal) or unexpected (emergency savings).
Save smartly by being realistic. It is fine to take trips or treat yourself to a spa day with your friends––the difference is making sure you save for it instead of treating it as an unexpected expense! You should not be using debt or credit for expected needs, wants, or goals. Being intentional with where money goes is an important part of being good stewards with our money. So, for these goals, it is better to have separate accounts for those funds; this assures the money saved for emergencies is left alone.
Like I mentioned before, of the 20% used to pay yourself first, one quarter of that portion (or 5% of the total income) is allocated towards savings. Although this is the usual recommended percentage of paying yourself first, this is not a hard and fast rule. If one is starting with a small amount of money or no savings, the twenty percent can be divided unevenly between the four categories, allocating more towards savings in order to create a steady foundation. Whatever portion goes to savings, typically putting two thirds going toward the short-term account and the other third to the emergency account is a good rule.
So, in the example where I am a young professional, of that $150 I had put aside for savings, $100 would go to the short-term savings account for my short-term needs/goals, while $50 would be used to fund my emergency savings account. Since more money was being allocated to the short-term savings account it should grow faster than the emergency savings account, which is being funded with less. By breaking down what the money in our savings is used for, we can also figure out how to best use the tools available to us to build up savings.
Savings, one of the most common uses for income beyond bills, is an important part of stewardship. To be a responsible steward of the money you earn, developing disciplined habits is crucial. Among these habits are living within your means, paying yourself first, budgeting, and smartly saving. Each of these principles can help you determine how much is feasible to save, giving you the ability to create a plan to save well and accomplish goals.
