Personal Finance Basics: Step 3

Step 3: Focus On Your Savings Rate

Two major steps are out of the way at this point. To review, they are:
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Step 1. Calculating Your Net Worth or Lifetime Earnings and Savings

Step 2. is broken down into 3 phases.

1. Eliminate debt (excluding mortgage)
2. Build a 3-12 month emergency fund.
3. Payoff your mortgage, in full

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After eliminating toxic debt and building an emergency fund, you will finally be in a position of relative financial strength. For step 2, focus hard on paying everything off. Some of you may want to keep your mortgage, but please realize that the interest on the loan (even if it is only 3%) can dramatically reduce the amount of money you are putting toward investing over the course of 30 years (average mortgage duration). Remember, over the course of a 30 year mortgage, the average homeowner pays 2.5 times the original purchase price​ due to interest.

Third Step: Your Savings Rate

The first two steps of this journey were highlighted in Part 1 and Part 2. If necessary, go back and review those. The sole purpose of putting those two steps together is to get to the point of attaining a positive net worth. 

After crossing the threshold into a positive net worth, now you can begin to focus on your savings rate. Savings rate is defined here as the percentage of your take-home pay put towards savings. 

Here is a typical way to begin figuring out your savings rate. It is broken down into 2 phases.

A. Find out what your after-tax take-home pay is by assessing:

• How much you are paying in taxes?
  • This includes Federal, state, and local levels as well as the employee and the employer payroll taxes - payroll taxes typical go towards funding Medicare and Social Security
• How much money goes towards your health insurance premiums?
• How much do you contribute to other employer-provided benefits including, but not limited to:
  • Vision
  • Dental
  • Disability insurance
  • Life insurance
  • Long term care insurance
  • Liability Coverage
  • Professional licensure or certifications

B. How much you are adding to the following accounts on a weekly, biweekly, or monthly basis?

• Employer sponsored retirement accounts
  • 401 (k), 403 (b), 457 (b), 401 (a), Definied Benefit plans or pension plans
• Self-directed retirement accounts
  • SIMPLE IRA or SEP IRA for business owners
  • Traditional IRA or Roth IRA for individuals
• Bank accounts
  • Traditional savings, CD's
  • Be careful including checking or money market accounts here since you are likely going to be spending from these accounts and not saving in these accounts
    • One exception would be those of you saving for a down payment for a home in a checking or money market account
• Brokerage accounts (taxable)

To calculate your savings rate, what percentage of your after-tax, take-home pay (section A. helps you determine this) goes towards accounts listed in section B. above.

Savings rate = (monthly savings amount/monthly take-home pay) x 100

Once You Know How Much Your Saving, Find Out How To Increase It!

Now that you have determined how much you are contributing to saving, look at this figure at least twice per year to see if you can increase it.

Never stop doing this step. Ever. You want to see throughout the "seasons of life" if you can be more and more aggressive with your savings efforts. Only you will be able to determine for how long and how much money needs to be accrued before you relax this plan.

Many have used The Shockingly Simple Math Behind Early Retirement article as a means for figuring out their "FI number". Perhaps this will be your next step as well.

To increase your savings rate, you can focus on income and expenses. Ideally, focus on both for the biggest impact. 

The goal: Increase income and decrease expenses simultaneously

Ways to increase income:

• Earn a bonus at work
• Ask for a raise
• Start a business on the side, or a "side hustle"
  • Blogging, eCommerce, Landscaping, etc.
• Do "gig" work
  • Freelance, surveys, Uber, Lyft, Fiver, Instacart, respond to Craigslist gigs (take your mace with you)
• Sell stuff on Craigslist or Letgo
• Update your resume and find a new, higher-paying job 

Ways to decrease expenses:

• Focus primarily on The Big Three
• After that, look into these secondary sources:
  • Negotiate or Research Lower Insurance premiums, especially home and auto
  • Improve energy efficiency in your home for a lower bill - some companies offer rebates on more energy efficient items such as buying a new refrigerator, etc.
  • Cook at home
  • Avoid buying new clothes
  • Wear out your old shoes before you get new ones
  • Regular vehicle maintenance to avoid big future expenses
  • Appeal your property taxes
  • Decrease subscription services
  • Reduce or eliminate cable services

The wider the gap between income and expenses, the greater potential your savings and thereby investments will have.

If you only have $100 saved, who the hell cares if you invest in something that generates a 25x return... you'd still only have $2,500 dollars---hardly enough to make you rich. This is a 2,500% return on your initial investment of $100. Guess what, "the market" typically returns 8-10% over time, not 2,500%. 

Remember, your most powerful weapon at your disposal is compound interest. The way you make compound interest even more powerful is by saving, early and often!

Summary

Step 1 - Calculate Your Net Worth or Figure Out Your Lifetime Earnings vs. Savings

Step 2 - Attain a Positive Net Worth (most often by eliminating debt) and create some breathing room with a fund of at least 3 months worth of expenses

Step 3 - Determine your savings rate and find ways to increase it

• Ideally you continue with step 3 for the remainder of your life---or at least the remainder of  your earnings lifetime