We’ve all heard our parents say over and over again that we’re supposed to save 10% of our paycheck, but now that you’re all grown up, have you actually taken the time to calculate just how much of your monthly income — if any — that you’re actually saving?
Even if you’re a habitual saver, and kudos to you if you are, but are certain that you’re actually saving 10% or more? Do you think that just because you automated your finances to route $100 of every paycheck into a high yield savings account that you’re actually saving 10%? If so, chances are good that you’re falling short.
After all, the mind has a frequent tendency to overestimate certain things (like finances) because we like to focus on the positive over the negative, so it’s not that surprising that most of us (me included) are notoriously bad at accurately forecasting how much we’re actually saving versus what we perceive that we’re saving.
Therefore, it’s probably in your best interests to do the math and find out where you stand.
Obviously, the easiest way to way to save X% of your bring home income is to automatically deduct X% of your paycheck and have your bank automatically route those funds into a savings account every month (or biweekly paycheck) so you can’t touch it. This approach takes advantage of the “out of sight, out of mind” principle and takes just a few minutes to setup.
However, while this is the most efficient method, it may not be the most feasible since you may need this extra X% of income to serve as a cushion to avoid being hit with overdraft fees or cover an unanticipated expense.
Therefore, you will need to use the following equation:
Monthly Savings = Cash Flow – (Unanticipated Expenses + Discretionary Expenses)
Using the cash flow equation, you can calculate exactly how much of your bring home income that you have available for potential monthly savings.
However, as the equation shows, just because you have potential savings and have $X amount of leftover funds to work with, it doesn’t mean that you’re going to save every dollar. If you’re like most people, you’ll have to deal with unexpected expenses (like a new set of tires, your pet needs shots, etc.) and you’ll want have some semblance of a social life.
Putting this equation to work, let’s use the example of a series of unplanned and discretionary expenses that could have hit any random male living on the Eastern Coast of the U.S. during February 2010.
Not surprisingly, the unanticipated expenses took a big bite out of potential savings.
Using the previous cash flow equation example, around 45% of monthly bring home income was available to use as we saw fit. However, thanks to unplanned and discretionary expenses, we lost another 31.7% of our bring home funds due to Mother Nature, car maintenance and having a social life. Not to mention, we also lost a sizable amount of income (and could have used more) to pay down credit card debt.
However, all in all, the person used in this example is still doing reasonably well and saving greater than 10% of their bring home income.
I hope that gives you some insight into where you stand. Regardless of whether you’re saving >10% of your income or you’re not saving a dime, chances are good that you will improve your situation by simply knowing this most basic of personal finance metrics because, like any journey, you have to know where you are to plot a course to where you want to be.
As always, if you have questions or need assistance in calculating your monthly savings rate, just leave a comment or use the contact me page and we’ll try to get you on the right track.