A friend of mine recently asked me for help with saving money. He is among the many people who don't save and don't have a plan. As an accounting professor, I'd like to share with you how I save money, just in case you're one of them.
It’s all about BUDGETING, which can help us understand where our money comes and goes, thus ensuring we avoid overspending and build up net worth. Let’s start with our current cash-in and cash-out by listing all our after-tax income and expenses for the current month. If the total after-tax income is more than the total expenses, we have a surplus and can save money. You can achieve it by increasing your after-tax income. If you work very hard, if you have some special skills or resources, or if you’re simply lucky enough, you may be able to create multiple streams of income. However, for the majority of us, reducing our expenses is the easiest way to build wealth before we become financially flexible.
Let’s break expenses down into three different categories. 1) Fixed Essential Expenses: the expenses we know are going to be billed to us. For example rent, mobile, internet and cable, monthly payment to car loans and house mortgage, etc. 2) Variable Essential Expenses: the expenses that we need to pay each month, but we don’t know exactly how much they might be. For example grocery, gas, utilities, etc. 3) Non-essential Expenses: the expenses that are basically our wants.
Now we should be able to develop a budgeting plan by deciding what changes we want to make to our expenses for next month. Here I want to introduce a popular 50/30/20 method, which means that you should allocate about 50% of your after-tax income on fixed and variable expenses, which are essential expenses. No more than 30% of your after-tax income should be allocated to your “wants”. Make sure you have the rest 20% as a surplus so you have enough for emergencies, enough to pay off your debts, and enough living expenses for 3-5 months in case you lose your job. You can even be more aggressive, let’s say use the 50/20/30 method. That means whenever you receive a paycheck, transfer 30% of your earnings to your savings account. You are forced to limit your wants in this way.
With this week's letter, I hope to provide you with strategies to become financially secure. But most importantly, I would like to encourage you to adopt a prudent lifestyle, and ensure you purchase only what you can afford, not necessarily what you want. The long-run will be fruitful for you. Cheers!
