Essential Concepts for Saving

Saving money can be challenging, but it is an important financial habit to establish. In many ways, savings are the essential building blocks of personal finance. After all, you have to save money before you can invest it. Borrowing money, while it may certainly be helpful, is often done because one does not have enough savings to maintain a certain standard of living. In this post, we discuss key concepts to understand and characteristics to aspire for when trying to save money.

Always have long-term goals

The reason we mention this as the first point is that it gives a purpose to saving money. In everything we do, we have a purpose behind it and the same should apply to saving money. Specifying a goal (eg. buy a home, children’s education, retirement savings) makes one more likely to actually make the intentional effort to save and make sacrifices in the short-term than if one were just saving for the sake of saving. Saving money without a purpose is also more likely to end up in one spending on impulse purchases that may not have been as well thought out as a long-term plan. In other words, having specific goals allows one to visualize what they want and have that vivid image in mind keeps one intrinsically motivated. Having a long-term goal also gives you the ability to carry on and be patient when times get tough as you are more likely to keep in mind the that the road ahead is still long. Finally, savings meant for long-term goals are more likely to be invested (eg. in the stock market) as time provides the opportunity to take risks and earn compounded returns.

Have a short-term focus 

This may sound like the exact opposite of the above point, however, this relates to managing cash flows in the short-term. In other words, keep track of where monthly cash flows from your pay cheque and bill and expenses go and plan accordingly. Think of it as breaking down your long-term goals into short-term objectives and practices to help you get there. For example, someone who prioritizes saving would likely save as soon as they get their pay cheque rather than spending on leisurely activities and saving what is left. A person with a savings mindset would also implement certain tactics such as delaying non-essential spending for the second half of the month (as an example) to increase the chances that one stays within their discretionary spending limit and not have to reduce the amount one planned to save for that month. Tactics such as these are also powerful because one can feel as though they are being rewarded in the second half of the month for abstaining in the first half, which creates a sort of positive incentive feedback loop

Emergency savings is a must

Unforeseen events cannot be anticipated but should be expected. One can lose their job, lose an important family member or even simply have to deal with a wave of unforeseen expenses. At the top of one’s priority list should be to have an emergency fund. Typically, the suggested amount is anywhere between six to twelve months of living expenses. Prioritizing having an emergency fund before other goals allows you to move on to saving for goals such as a down payment on a home or a vacation with more confidence and comfort. The last thing you would want is for a large chunk of your retirement fund to turn into your emergency fund because something came up. With saving, it’s all about being prepared and proactive.

Be intentional 

Having a budget is not just about tracking expenses so you are aware of where your money is going. You need to have the will to stay within the budget and be consistent and disciplined. This is important because as humans we tend to act on impulses and have a bias towards the short-term. This can result in financial decisions or use of savings that may not be as well thought out as we would like. To counter this force, one has to have the clear intention to save and having a specific target in mind helps with this.

Be flexible

Life is dynamic and always changing. As such, your savings goals might need to change with it. Maybe you have a new addition to the family and your living expenses go up. In turn, this would mean your emergency fund may also need to increase. Later on in life when the kids have moved out, the opposite might occur where living expenses are lower and some of your emergency savings can be moved to other goals. In addition to being flexible with changing life circumstances, one should also be flexible in their thinking about their budgeting and savings plan. If you do not end up meeting your monthly savings target for six months in a row, perhaps something should change. Perhaps you need to reduce spending in one category or even lower expectations for how much you can realistically save. Being flexible is also critical when you are budgeting and setting savings goals with your significant other as you both may have different views on the household budget and, in turn, compromises may need to be made to find some common ground.

It’s all about habits

Saving money is all about behaviours and habits. This is an important point because habits take time to build and of course, old habits die hard. Therefore, one needs to have patience with themselves and others in the same household when trying to establish better savings habits. Understanding this also means one has to make a consistent effort every month until better habits come more naturally and are engrained in the monthly routine. Finally, habits are made up of small actions, and to save money, sometimes it is just a matter of small tweaks to everyday life. For example, automating your savings so that a set amount comes off of your pay cheque can really go a long way and even simplify your finances.

Dont just save, invest!

Investing and saving can be synonymous if your time horizon is long enough. If you have a savings goal that is more than five years out, consider investing that money. This is where you can really make withholding spending in the present worthwhile as returns compound on each other over time. Think of it this way, saving $300 a month for 10 years will land you about $36,000. If instead you invested this $300 every month and earned an average of 8% annually, that number would be closer to $55,000. Investing, rather than just leaving money in a (low interest) savings account, also counters the negative effect inflation (~2-3% annually) has on your purchasing power 10 years from now.

Enjoy life

Saving money can be challenging and even stressful, so it is important not to lose sight of your personal well-being in the process as well as other things in life that are important to you.  On the one hand, rewarding yourself when you have reached your savings targets or milestones is a good self-motivator to keep doing what you are doing. After all, you deserve it! On the other, doing things like spending quality time with friends and family make us thankful for the most valuable things that are already in our lives. Finally, being mindful of these things and having a sense of gratitude can also make going through the sacrifices of saving money a whole lot easier.

Moez Mahrez, CFA

Analyst for 5i Research Inc.