A guest post from Eric Zhang in the United States.
How and Why to Start Saving Responsibly
Planning, Budgeting, Savings, Retirement. For most, I can already feel your headache coming on. I admit, getting the motivation to save and manage your personal finances can definitely be tough – it’s a constant feeling of responsibility, burden, and sacrifice, especially for those beginning your career or continuing your education. It can seem difficult as well, requiring a lot of planning and work to properly save and prepare for retirement.
Before going into a few tips on how to get started, however, here’s why you should be taking it seriously.
Why Save Responsibly
1) Financial Health
This is a bit obvious, but saving responsibly makes you financially sound, ensuring that you have ample savings to handle emergencies and enough to draw out from in retirement. With a proper budget, you can create a buffer zone for those emergencies, handle all regularly incoming bills without a hitch, and understand how much you can afford to splurge. Without it and proper savings, you can be forced to less than ideal options, such as taking loans from friends or payday providers, dipping into your retirement account and paying penalty fees, or taking the hit on your credit score.
2) Psychological Health
We have enough going in our lives – why not take finances out of the equation and make it one less thing to worry about? Building upon the point from above, knowing that you have savings to cover emergencies and the proper budget to handle your bills can significantly reduce stress, especially for those that live paycheck to paycheck. Rather than living in fear, you live in control, understanding how every financial decision impacts you and whether or not you can afford it.
How to Start Saving Responsibly
To help obtain financial and psychological health, here are three pieces of advice on starting to save:
1) Understanding the Short Term – Daily Decisions make an Impact
The example I love to give in understanding how daily decisions make a difference in saving for the long term is with workday lunch and coffee. As illustrated below, a standard lunch and Starbucks can add up to roughly $5000 of your salary – that sounds pretty rough, right? This doesn’t even measure weekend food bills or weekday dinners!
We’re not done yet! It is also important to note the principle of compound interest, which is the concept that a lump sum of money growing at an interest rate will grow faster every subsequent year because of the bigger lump sum every year. Let’s take a look at an illustration from Business Insider which shows that $300 a month from 25 to 65 at a reasonable interest rate of 5% can net you nearly $500,000 by retirement.
2) Understanding the Long Term – How Much Do You Really Need to Save?
The point of saving and budgeting for retirement is to ensure that you have money to withdraw from when you no longer work. With that in mind, it makes it easier to look at it from a financial perspective to plan accordingly instead of guessing haphazardly.
First, calculate your expected retirement age and death (a bit grim, but certainly helpful for planning purposes). Estimate the amount of money you’ll need to withdraw every month for those years, and use the following formula/calculator to figure out the lump sum you need at retirement.
Here’s an example where I’ve used some conservative numbers:
Amount Withdrawn every Month in Retirement: $4,000.00
Rate per Period: .417% (derived from an annual interest rate of 5% / 12 to give the monthly rate)
# of Periods: 240 (derived from 20 years * 12 months)
Then, you can use the future value of an annuity calculator (calculates the future value of a recurring deposit) to figure out the amount needed to save every month to reach your goal at retirement. To put it all together, the diagram below shows what I have just calculated. I need to save around $400 a month from 25 – 65 in order to withdraw a comfortable 4000 per month in my 20 years of retirement.
3) Don’t Forget to Splurge!
This may seem counterintuitive, especially after showing calculations of how daily lunch and coffee over 40 years can become $500,000, and how saving $400 a month can allow one to live comfortably in retirement for 20 years. However, going back to the psychological benefit highlighted above, psychology plays a huge part in motivation and maintaining a balanced lifestyle with savings. It is not reasonable to skimp out every lunch, coffee, and every expense
possible. I highly recommend setting aside some money to splurge in order to maintain short-term happiness while balancing your savings for your long-term happiness.
Saving is very important, and it is very useful to understand how short-term decisions can influence your finances and how to properly plan for your retirement, and the impacts it has on your financial and psychological health. Think about how and why to start saving responsibly today! And remember: it is a marathon, not a sprint, and that everything should be done in moderation. Please let me know if you have any questions on any of my points, or if you have any additional pieces of advice on saving responsibly!