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How To Increase Your Savings

It has been said that to become a millionaire in 30 to 40 years you just need to save $5 a day.  This advice overlooks two main factors in savings: the amount of money you actually need for retirement and the amount of time you have to save that money. 

Before you start counting on becoming a millionaire, consider the following:

  • Determine how much you need to save.

    It may sound obvious, however, it is often overlooked.   There are several problems with just using an arbitrary number (e.g. saving $5/day):

    1) Investment Return - Most of these millionaire projections use a 10% to 12% rate of return on your investment, which may be reasonable if you only invest in equities with low investment management fees.  However, most people may want to diversify their investments into other vehicles (e.g. in bonds) which typically have smaller returns.  The difference in assuming a 10% return and an 8% return based on saving a flat amount each year would result in a 30% lower balance by the end of the 30th year.  It is important to understand the impact of investment return on savings over time.

    2) Inflation - The value of $1 million in 30 years is equivalent to approximately $400,000 in today's dollars and $300,000 in 40 years (assuming 3% inflation). 

    3) Retirement Needs - Before becoming fixated on a goal of $1 million, realize that some people may need $500,000 (or less) for retirement while others may need $1 million to $5 million depending on their age, expenses, and company's pension fund.  You need to understand what you need to replace your current income in retirement.

    This does not mean that you should give up on the idea of being a millionaire.  It does mean that you should determine how much you actually need (e.g., for retirement) and plan your savings accordingly. 

  • Make your goals more tangible.

    If you say that you want to increase savings, what is this statement?  It is a goal.  A goal has a better likelihood of being met if it is real and tangible.  If your goal is to lose 100 pounds. That is a good goal.  Yet, your goal will be more attainable when it becomes more vivid and impactful.  In other words, what is the real reason for your goal?  A more vivid goal is "I want to lose weight in order to decrease my blood pressure to 120/80, and live long enough to see my grandchildren graduate from college."  This is not just about weight loss; it is about being healthier by having a better blood pressure.  It also becomes a desire by wanting to see your grandchildren graduate from college.  So when you go for that piece of candy, you picture yourself at your grandchildren college commencement and have more motivation to avoid the piece of candy versus just wanting to lose 100 pounds.  Desire creates energy.  Energy produces results.

    If you are saving for a vacation, then picture yourself at your vacation destination.  If it is for retirement, then picture yourself enjoying your retirement, playing golf or sitting on a beach with a drink and a book.  You can make posters of your goals and desires using pictures from magazines.  Use these posters to remind you of your goals and motivate you to save.

  • Determine how much of an increase in savings you need.
  • If you need just a minor adjustment, then the $5 a day proposal may be just what you need.  Yet, if you need more than a minor adjustment, then saving $5 a day may not be enough.  Determine how much a month or year you need to save to meet your goals.

  • Review your budget.
  • Challenge yourself on all your spending categories, looking for ways to cut expenses.  This goes from housing and vacations to the daily cup of coffee.  You may have to give up more than a cup of coffee to meet your savings goal.  You may actually need to change your lifestyle (vacations, cars, or home), if your goal is to save $15 or more a day. 

  • Write down specific changes to your budget.
  • Write down exactly what your game plan is and keep it somewhere that you will see it weekly to review how you are doing.

    Create intermediate goals.  If you have a long-term plan for retirement, break it up into steps for each of the next 5 to 10 years.  Having a single long-term goal may be too overwhelming.  It is easier to break it up into smaller amounts.

  • Celebrate your successes.
  • When you are meeting or exceeding your goals, celebrate the successes.  Have fun with the process, and acknowledge your hard work.

Food for Thought - other saving recommendations that do not work

"When you get a raise, save half and spend half."

    Let's say you get a 5% raise.  If you follow the advice above, then you would spend 2.5% on an upgraded lifestyle and save 2.5%.  Yet, what about inflation?  Really, the raise was  only 2%, assuming 3% inflation.  So, if you increased your spending by 2.5%, you would find yourself quickly going over budget, unless you cut back on other areas.

    In today's environment, many employees are getting raises equal to inflation or less.  Thus, there is nothing additional to save.  In fact, you may need to cut other areas of your budget if your salary does not keep up with inflation. 

    Alternative Recommendations:

    1) Save part of the increase above inflation (in the above example, 5% raise - 3% inflation = 2% to save and/or spend -- save part and spend part).

    2) Increase your savings annually (e.g., 1% annually).  For example, if your savings goal is 10% and you are saving 5% a year, increase your savings by 1% a year.  Finding ways to save 1% a year is more manageable than a dramatic 5% all at once (especially if you have large fixed payments like a mortgage and/or car loans).  This will create a gradual transition to a more manageable lifestyle that will allow you to adjust your budget over time, for example, when you buy your next car.

"Pay yourself first."

    This is becoming a popular tool for savings.  They say that by putting your target savings into a 401(k) fund or automatic investment fund, then you will meet your savings goal because you are not tempted to spend the money that you do not have due to being automatically invested.  The premise in this advise is that people have a tendency to spend what they have.  "Pay yourself first" does not address this behavior but tries to work around one's spending problems.  What it fails to account for is timing of certain expenses.  Assume that in December buys holiday presents and is forced to repair the furnace that broke down.  With these additional expenses beyond their normal spending budget for the month, they are forced to tap into their emergency fund, for items that are not really emergencies .  Appliances will break down and should be budgeted for instead of being an emergency.  What happens if this person lost their job in February before being able to replenish the emergency fund? 

    "Pay yourself first" can be beneficial in saving money, however, it does not replace a budget.  Many have succeeded with this approach.  Others that got hit with unplanned purchases (e.g., appliance repairs) followed by real emergencies may not have succeeded.  To illustrate this, I wonder how many people in the North did not sit down and plan for the higher home heating costs for the winter of 2005/2006.  In January and February they are stuck with needing to pay bills may have needed to tap into the emergency fund because they did not change their spending habits soon enough.  Yet, for those with a budget, these discussions are made in September and October about how they need to allocate more to heating costs and can discuss where to cut other expenses to meet their budget.  These families who plan maintain their emergency funds for true emergencies instead of using it for unavoidable purchases that were not planned for.

    Alternative Recommendation:   Having a budget about how much you will spend and save can not be eliminated.  You can save automatically or by transferring the money yourself each month.  There is nothing wrong with pay yourself first as long as you retain the power over your budget rather than the forced savings controlling you.  I say this because you may find a way to save even more by going through the budget process first.  In addition, if you have additional income in a month (e.g., unexpected bonus), you will be more likely to consciously decided whether to spend it or save it.  Where under pay yourself first, unconscious spending has not been addressed, so one is more likely to spend the extra income automatically.

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