Imagine trying to buy a house for a huge discount, but you find out you don’t have enough money in the bank. Now imagine trying to buy that dream Mercedes, but you simply don’t have enough to put down for a down payment. All of these issues relate to the concept of savings, which is one of the top reasons why financial illiteracy is a huge problem in society today. This article will provide you some of the reasons why it’s important to save as well as some of the different strategies you can use to put more money in the bank.
So first of all, why is it important to save money? The simple answer is that you’ll need money at some point in the future to cover whatever expenses you’ll incur, whether it’s an emergency or paying for college. It is very critical to start saving as a kid because money accumulates value over time.
Imagine opening up a savings account at the age of 13, putting in $100 a month (whether it be an allowance or money you earn), and the bank hypothetically pays you 1% interest each year. Now imagine if you did that up until you hit 21 years old. So $100 a month times 12 months in a year is $1,200. At a 1% rate (compounded annually), you also earn interest of $12 for that year. At the age of 14, you now have $1,212 in the bank. Since interest compounds/adds up each year, you will end up with a total of $11,242.23 by the time you turn 21! There’s a simple calculator you can use online to find this number known as the future value of an annuity, but basically, what this means is that if you save $1,200 a year for 9 years (i.e. from age 13 to age 21) at a 1% interest rate, you’ll end up having $11,242.23 saved in the bank, when you only had to put in $10,800 (i.e. saving $1,200 a year times 9 years). This is just an example of how saving money can make you even more money. Now imagine saving $200 a month or even $300 a month at the same interest rate or even better, at a higher interest rate.
But the true importance of saving money is not how much interest you can earn on that money, it’s how you can set yourself up for success in the event something happens in the future. Let’s say you incur a huge medical expense and unfortunately, your insurance company won’t cover the costs. Having money saved up in the bank can easily help reduce this stress and ultimately, take care of that debt. Or let’s say you’re 13 years old and you want to go to college at one of the best universities in the nation and your parents unfortunately can’t help you with the costs. By saving money, you will better prepare yourself for this scenario in case you don’t get scholarship funds or you need some extra money to help pay off your tuition.
So now you understand why it’s important to save money, but to recap, the two reasons are to prepare for unforeseen events such as emergencies and to prepare for future known expenses such as paying for college. So now to the ultimate question of “how.” Aside from the scenario of the 13 year old above, there are many different ways you can save money.
The key to saving money is to form a plan of how you want to save and exactly why/for what event are you saving for.
Saving for Emergencies
Clearly there’s no true guideline to save for an emergency as we don’t know when the emergency will happen or what effect it’ll have on us. This is where following the general rule of thumb of saving is important. My general rule of thumb is to save at least 50% of the money you have as “spending money” or disposable income. To come up with your spending money, simply take all of your income (all the money that’s coming in) and subtract all of your necessary expenses (all the bills). So now, you have all of your bills taken care of (hopefully) and you have some spending money. Put at least 50% of that money in the bank and the rest, you can use to spend on whatever you want to or better yet, save more of it or put it into an investment such as a retirement account. Always remember that spending money does not necessarily have to be spent. It’s simply money that you have that gives you the option to spend. I normally recommend using this saving strategy on a monthly basis. By putting away at least 50% each month, you will be better prepared for any unforeseen events that come up in the future and you’ll have some money in the bank to use later. If you've exceeded your savings goal, try to find other investment alternatives.
Saving for a “Known Expense”
Let’s say you want to go to college and you’re 16 years old, you got your first job that pays $9 an hour and you work 20 hours a week. Your parents help you take care of most of your bills, but you’re in charge of only one bill, which is your phone bill at $40 a month. You plan to enroll in college by the age of 19, giving you three years to save money. Luckily, your parents put $5,000 in your bank account when you were a child and it collects interest of 1% each year. So your current bank balance is $5,862.89 (future value of $5,000 collecting 1% interest for 16 years). So now let’s take $9 an hour times 20 hours a week which is $180 a week times four weeks in a month is $720 a month. Let’s say $100 of taxes are taken out each month leaving you with $620 of take home pay (income) each month. Subtract your only expense of your phone bill of $40 and you’re left with $580 of disposable income. Now let’s put $500 of that money in the bank each month, while you spend the remaining $80. So now you have $500 going in the bank each month at a 1% interest rate for three years straight. That leaves you with $18,264.89 by the time you’re 19 years old! And let’s not forget about your other $5,862.89 which by the time you’re 19 years old, has now reached $6,040.54! Add $6,040.54 to $18,264.89 and you now have $24,305.43 saved for college, ready to help you take care of some of your college expenses. Now of course you’ll need more to get you through four years of college at a top ranked university, but you now have $24,000 less to worry about. And as far as the calculations, I simply used a calculator on Google to plug in the numbers so don’t cause yourself a headache by solving these by hand. Please feel free to ask me how I got all of these numbers.
Increase those saving amounts in different scenarios and you put yourself in even better position to help you get that 4 year degree you’ve always dreamed of. As a personal note, I went to college with only $1,000 in the bank. So clearly, I could’ve used some of this advice too. Just be sure to continue applying for scholarships and financial aid to put yourself in a better position to get through college. And if you absolutely have to take out a loan to get through college, then so be it. You’re investing in your future. This saving strategy doesn’t only apply to college, but you can apply it to saving for a home, car, or even a child or two. Just remember that a failure to plan is a plan to fail. Always set a plan for what you want to save for and build a budget as well as savings’ goals around that plan. You will set yourself up for success.
I hope this provides you with some insight on why it’s important to save money and how to save money. By saving money, you will be better prepared for both planned and unplanned expenses/events. And as an added bonus, interest rates have gone up this year, giving you some more money in the bank. Be sure to look into different banks and if you want to make the most of your money, choose the bank with the highest interest rate.
If you have any questions or concerns, always feel free to reach out to me.