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Financial issues can create strain on many people. According to a 2015 American Psychological Association study, 72% of adults say they are stressed about money at least some of the time. It doesn’t have to be this way, though, especially if you can change your money habits to become an excellent, consistent saver.
Understanding your cash flow is the first step to becoming a better saver. This means looking at your income versus your expenses. As your income increases, your expenses often do, too. Of course, you want to make sure that your income exceeds your expenses, but even if you are continually spending less than you make, that does not necessarily mean there aren’t any bad financial habits you need to break. On the flip side, just because you don’t make a ton of money doesn’t mean you can’t be a diligent saver and alleviate some financial strain.
Saving up, down and through
In fact, some of the poorest people in the lowest income brackets are very skilled at saving and managing their money. Stuart Rutherford — a microfinance expert and the founder of SafeSave, a financial services cooperative in Bangladesh — has written about how the poor frequently “manipulate their savings through a wide range of methods of saving up, saving down and saving through.”
Rutherford describes three different approaches the poor have to saving, but we can see through the examples cited how each method might be applicable to households with greater wealth:
- Saving up: This means the household’s savings are added to, bit by bit, until a large enough lump sum has been amassed to serve an expenditure need. An example of this would be putting aside a percentage of every paycheck over the course of a year until enough is saved to move into a new home.
- Saving down: This refers to the process of taking out and then repaying a loan. It is similar to saving up, but with the added bonus of being able to afford an expenditure now rather than later. A common example of this method is when families with college-age children elect to take out a student loan to cover the costs of the child’s education.
- Saving through: This is a combination of saving up and saving down. In this scenario, a household receives a lump sum at some point during their savings process. An example of this would be certain types of insurance coverage. Money is saved in monthly installments, and then the sum of the savings becomes available when an accident occurs.
Although much inspiration and many lessons on saving can be gleaned from the savvy practices of the poor as described by Rutherford, another method of saving may work even better for you. For most people who have regular and adequate income, the best and most consistent method of saving is following the simple and elegant 50/20/30 budgeting rule of thumb. In a sense, the 50/20/30 rule can be likened to “saving as you go.” It certainly involves saving up, but presumably over a much longer time horizon — the individual’s lifetime.
The way this savings plan works can be found in the name. Income is split into three portions: The first 50% goes toward everyday needs, such as rent, groceries and bills; the next 20% goes into long-term savings for things like retirement, or it can be applied to any debt that needs to be factored into the equation; the remaining 30% is what is left over for recreational activities and splurges.
With this plan, you can see that it’s crucial to think carefully about what expenses are absolutely necessary and which ones should fall into the “splurge” bucket. There is nothing wrong with shopping, attending a baseball game or even taking a trip to the Bahamas as long as the money for those activities is coming from the right portion of your paycheck. Failing to think about the repercussions of your purchases is like ignoring the iceberg and leading the Titanic to its demise. While that new sports car may feel like a need — it may seem important to maintain your status in society — I promise you it is not. But by saving and consistently monitoring your progress, you will have a better handle on your finances.
The 50/20/30 plan has more to do with changing your behavior to become a better saver than with saving up until a specific amount of money has been amassed. With this method, you save more as you start to make more. You train yourself to consistently spend wisely, carving up your income in a way that will sustain your lifestyle while at the same time help you prepare for the future.
Plus, having more money in the bank instead of splurging on whatever seems necessary at the moment lets you embrace life rather than waste your money on meaningless material goods. Save regularly and continuously so you can live the life you want, free from financial stress.
This article also appears on Nasdaq.