A good savings habit is the foundation of wealth creation
Even at an early age when you received pocket money, you were faced with the decision of what to do with that money. Some chose to save part of it and put in a bank account (or piggy bank). Those savings became the seed of your retirement capital (whether you realised it or not).
Many people believe that wealth is created by buying and selling assets. While that can explain part of the story, if you never save any money, you’ll never have any capital to “buy and sell assets” with. Savings is the oxygen that feeds the wealth creation fire.
In this article we look at ways to improve your level of savings (and ultimately your ability to attain financial independence).
Spend time consciously saving, rather than unconsciously spending
The most successful way to save is through the “pay yourself first” approach. Our superannuation system, that directs some of our earnings into a super account before we get to see it, is a great example of this approach. It’s a very effective way to save. Not only is it tax efficient, it ensures you save before you get the opportunity to spend. Most people don’t even notice the withheld amount.
Not all saving occurs this way though and the next best way to improve your level of saving is by managing your spending. Personal budgeting is the most effective tool for this purpose.
Few people we meet manage their affairs using a personal budget. Some believe budgets are only for those who do it out of necessity. Few choose to do it. Yet, budgets are simply a way to measure your progress against your expectations (or goals).
Knowing how much you spend and where you spend it can prove to be very enlightening. Studies have revealed that, on average, people who get into the habit of monitoring their money wind up wealthier than those who don’t.
With savings being such an important driver in attaining financial independence, it stands to reason that putting the time and effort into consciously saving is a very good habit to develop.
For those who think that a reduction in spending will lead to a life of misery, the news is not that dim thanks to the phenomenon known as “hedonic adaptation”[1.]. This reveals that we quickly become used to changes, good or bad, in order to maintain a stable level of happiness. So a reduction in spending is unlikely to lead to any lasting deterioration in your happiness. For some, the act of taking control can actually improve levels of happiness.
You also need to recognise the flip side to this phenomenon. Studies show that people often feel less pleasure and happiness with each additional purchase. Some develop an addiction to spending in an attempt to perpetuate that initial purchasing euphoria. This can lead to over spending and ultimately a reduced level of happiness.
Understanding your spending pattern provides you with choices that can lead to greater happiness.
Our experience suggests that people develop a certain spending habit that increases in step with their earnings. This habit tends to continue unconsciously and is often only challenged in the event of a crisis (e.g. job loss, health scare). Subsequent changes are usually short lived and inconsequential (i.e. they don’t become habitual).
To get a meaningful benefit from changing your spending pattern, the change needs to be sustainable. It needs to be deliberate and consistent and involve regular feedback.
Measurement and comparison are essential to this process of change. In the past, when cash was the most accepted form of payment, we had an easier mechanism for measuring our spending. Physically, cash left our pockets and we were left with the residual as a daily reminder of our spending pattern. These days, with the use of credit cards (and easy access to debt), it’s harder to keep track of our level of spending.
Fortunately, there are personal financial software packages that can assist and allow you to track your spending/savings against expectations and thereby provide valuable feedback.
These include Quicken, AceMoney, Moneysoft and Xero (with some able to accept automatic daily feeds of your bank and credit card transactions). Another handy tool with less functionality is Track my Spending. While these systems aren’t essential, they are pretty cost effective and it’s difficult to replicate their functionality.
Monitoring your savings is the first step
“Measurement is the first step that leads to control and eventually to improvement. If you can’t measure something, you can’t understand it. If you can’t understand it, you can’t control it. If you can’t control it, you can’t improve it.” H. James Harrington
Your level of lifetime savings is a critical contributor to your ability to achieve financial independence. Some people (mostly those who don’t have a good track record of saving) hope for magical solutions to achieve their financial goals, like relying on abnormally high rates of return. They are often the subject of stories about losing their hard earned savings in high risk investment schemes.
If you want achieve financial independence by design rather than by accident, a savings plan that incorporates regular progress reviews and the necessary behavioural adjustments is a critical requirement.
[1.] We’re talking about reductions in spending that will leave you with a spending allowance that is still above your basic needs.