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Money Tip – October 17, 2019

Today’s Money Tip has to do with a number that I hope you’re tracking – your Savings Rate. Here’s why it matters so much.

When I worked with families to help them solve financial challenges, I realized that many people who reached out to me for help shared a common trait.

It wasn’t their background, income, or educational levels. Nor was it their occupation, interests or experience with money. As far as I could tell, there was no common link with any of those factors.

What they had in common, though, was a similar leading indicator revolving around savings.

What on earth is a leading indicator?

In the business world, we keep track of various metrics. Some, such as the number of followers you have on social media platforms, are called vanity metrics: they make you feel good, but don’t necessarily translate to business success.

Others, like the number of people you speak to on a daily basis if you’re in sales, or the number of conversions on your website if you sell products or services online, are tied to your ultimate success. It’s one of several measures of progress known as Key Performance Indicators.

Here’s how KPI.org defines the terms:

Key Performance Indicators (KPIs) are the critical (key) indicators of progress toward an intended result. KPIs create an analytical basis for decision making and help focus attention on what matters most….

Leading indicators are precursors of future success…. 

What does this have to do with personal finance?

Financial success leaves clues. If you want to address a financial area that is currently a challenge, the trick is to look at people who either don’t have that problem, or who have overcome it, and ask yourself, “What are they doing that I’m not?”

In other words, what are the behaviors – the leading indicators – that are the precursors of future success? What needs to happen in your world to get positive results, too?

One of the things that struck me when I first started working as a Financial Repair Specialist was that few of the people who reached out had managed to save money.

Some had a few dollars in a savings account or small amounts of investments, but for the most part, there was no buffer and no surplus at the end of each month.

In fact, credit card and Line of Credit payments took up all the extra cash after paying for whatever level of lifestyle my clients maintained.

It didn’t matter if they had a family income of $50,000 or $150,000; the outcome was the same: no savings + financial challenges.

In more than ten years, I rarely encountered clients who incorporated regular savings habits into their day-to-day money management. Their process typically looked something like this:

Receive money from employment or business —> pay bills —> spend money —> save what’s left (where what’s left ≤ $0).

The result? Financial pain.

#1 Leading Indicator for Financial Fitness

Arguably the most important number for your finances is your Savings Rate. How much money are you managing to save (and invest), over and above your expenses, every month, expressed as both a dollar amount and a percentage?

Here are a couple things that your savings rate tells you:

  1. Whether or not you’re living within your means. You can’t save money unless you’re spending less than you make. This is a necessary condition. Without this step, there is no way to achieve financial security or freedom.
  2. The higher your savings rate, and subsequently, your investing rate, the sooner you will achieve financial security, then financial freedom.

All financially successful people grow their savings, and their investments, year in, year out. It’s a priority for them because they understand that it’s necessary to achieve their financial goals.

If you’re thinking, “Sure that’s all fine and good for people who earn a lot of money, but how can I do this on my modest income?”, I encourage you to read The Millionaire Next Door, by Thomas J. Stanley and William D. Danko. It’s not about how much you make; it’s about how you use your money.

Don’t get me wrong: Growing your income is the fastest way to build your wealth. I’m a big fan of that approach! However, if you keep spending more than you earn, no amount of income will help you.

Percentage matters

Why the insistence on dollar amount and percentage? Very simply, the dollar amount can be misleading. If you’re currently saving $1,000 per year on an after tax income of $50,000, that represents a 2% savings rate.

Let’s say that next year you get a raise and you’re now bringing home $55,000 after tax. If you don’t change the dollar amount you save, your savings rate will have fallen to 1.8%. You might still feel good about saving $1,000, but in reality, that number represents a slide backward in terms of your overall savings rate.

By keeping track of the dollar amount and the percentage saved, you’ll have a more comprehensive check point on how you’re doing.

In next week’s post, we’ll look at how you can use your savings rate to determine if you’re on track to meet your retirement goals. One thing is certain though: If you’re not managing to save money on a monthly basis, the future holds more challenges for you.

The good news is that you can make a choice today to take the reigns of your finances, control your spending, tackle corrosive debt mercilessly, and build up a savings rate that will help you achieve your most cherished goals. It starts with a decision and a commitment to proceed one step at a time.

It is doable, regardless of the situation you’re in. I can say this with confidence as I’ve helped many families in difficult circumstances, with varying income levels, climb their way out of nasty financial holes.

What’s your rate?

Pull up your calendar and find a time within the next seven days where you can sit down for one hour to calculate the following:

1. How much you bring in, after tax, every month. If you’re self-employed and the amount varies from month to month, use averages based on annual figures over the last two to three years.

2. How much you save every month. This is money that you send to a separate savings account to a) top up an Emergency Fund; then b) invest. Money that you’re saving for a purchase doesn’t count since you intend to spend it in the near future. I’m talking about cash set aside to grow and fund future living expenses.

3. Calculate your Savings Rate as a percentage: Dollars saved (e.g. $1,000) ÷ After-tax income (e.g. $50,000) x 100 = Savings Rate (e.g. 2%).

Key Step

Now the key step: How can you increase your Savings Rate, even by a little? Which expenditures, particularly the ones that don’t line up with your values, can you reduce or eliminate to increase your savings?

Next, how can you earn a few extra dollars every month to funnel into your savings and investments? I just heard from a single mom of two young boys who took on a contracting gig outside of her full-time job to bring in extra cash. It’s the same work she does during the day, making use of already-existing expertise. In just a few months, she’s managed to save more than $1,300. How cool is that?

Clamp down on expenses, then look for sources of extra income to grow your savings rate.

Reach out to let me know how you make out with this tip. I’d love to hear your stories.

Finding it tough? Reach out with those thoughts, too. Our community is here to support you.

Have fun saving money! I can tell you from personal experience that it’s addictive. The more you save, the more you want to save. The more you want to save, the more creative you get about making money. It’s a powerful loop. Give it a try and email me with your results.

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