Understanding how you’ll achieve your financial goals starts with understanding where you are now. Even for high earners and especially for those focused on achieving financial independence quickly, a savings plan is a simple but powerful tool to help you be purposeful about where your money is going. We’ll walk through the basics of building a savings plan and provide some suggestions on how to stick to it below.
Step 1: Income
Start with your monthly household income. Add up your earnings, your spouse’s earnings, income from passive sources like rental income, royalties, and investment-related income like dividends and interest. You’ll then want to take out the portion of your income that goes to the government as taxes to get your monthly after-tax income.
Step 2: Expenses
Catalogue your expenses. These can vary month by month, but your goal is to understand your obligations, your discretionary spending, and what you have left over for savings. That means it may be easier to look at a full years worth of expenses and then take an average to get to a monthly view. There are a number of apps like Mint that make this cataloguing process a bit easier.
Separate your expenses into obligations, like rent or mortgage payments, food and utilities, debt servicing, and any other critical expenses that you can’t possibly avoid, discretionary, like restaurants, travel, and entertainment expenses, and savings, which will be what you have leftover after subtracting the other two categories from your income.
Step 3: Examination
Good work! You’ve done the hard part. Now it’s time to take a step back and look at how you spend. Were you surprised? Are you happy about where your money is going? Are there expenses that surprised you, that you had forgotten about, or that you no longer need to pay for?
Next, ask yourself (or speak to a Farther financial advisor about) whether your savings are enough to meet your financial goals as quickly as you would like. If they are, great! You already have a plan that’s working, even if you haven’t written it down yet. If not, that’s where our next step comes in.
Step 4: Plan
Developing a financial plan can sound ambitious, but even a simple savings goal can be sufficient to start. Begin with a realistic target savings amount. If this is over your current savings, it’s time to identify where you want to cut expenses to achieve that savings goal. Take a good hard look at the discretionary category to see what you no longer need or can live without. If that’s not enough, it may be time to revisit some of your obligations and ask yourself if you can refinance your debt to lower interest payments or opt for a less expensive housing situation. If you’re still not where you want to be, consider ways of increasing your income to compensate.
What’s a good target savings rate? The average savings rate in the US is 9%, but Farther (and most financial institutions) suggest a savings rate that’s a bit more ambitious in the 20% range. If you’re consistently putting 20% of your income into debt repayment and savings, you’ll likely be on track to achieve your financial goals while still having enough put aside to cover emergencies and to indulge every once in a while.
Step 5: Execute
Once you have a savings goal and a plan for achieving, the final step is to follow through on it. First, make sure you’re tracking your progress. Keep track of your expenses and see how closely you’re sticking to your goal each month.
Often, the process of tracking your spending alone is enough to begin shifting spending away from purchases you don’t really need to make towards savings and progress. And if you don’t see immediate improvement in your savings rate, don’t be be discouraged. Habits take time to form.
You can also give yourself a big step up by automating your savings. Make sure you’re paying yourself first by sweeping your target savings out of your bank account each month or setting up a recurring contribution to your goal-based accounts. To learn more about how to optimize your savings, check out this article.
Finally, revisit both your plan and this budgeting exercise each year. Update your goals as needed, adjust your savings rate as they change, and stay on top of your expenses so that you’re never paying more than you have to.