Saving is the First Step
In a way, saving means being able to sacrifice a part of the present for the possibility of a better future.
In any journey, taking the first step can often be the hardest step to take. Still, it can also be the most important step.
In the context of financial literacy and financial freedom, the first step is saving. In a way, saving means being able to sacrifice a part of the present for the possibility of a better future.
At the onset, the savings goal must be defined in terms of financial value and also in terms of time horizon. How much money do we need to save? How long should the time horizon be? Having a clear goal helps guide our way of living. Having a clear goal positively influences our priorities, planning and behavior.
There can be a short-term goal and a long-term goal. An example of a short-term goal is building an emergency fund. Total monthly lifestyle expenses can be multiplied by anywhere between six months to 12 months to compute the emergency fund needed. The emergency fund comes handy when unfortunate events like job loss or medical conditions occur. An example of a long-term goal is building a retirement fund. Projected lifestyle expenses during retirement can be the basis in computing the required amount.
Once the savings goal or savings goals have been defined, we have to take stock of our level of income. There is active income which we earn from working, while there is also passive income which we earn from investments.
The total income that we receive should serve as the basis of our lifestyle. We should try our best to live within our means. Having an unsustainable lifestyle can lead us to serious debt problems.
The common formula many people apply in saving is “Income minus spending equals saving.” This can be modified into “Income minus saving equals spending.” Giving utmost importance to saving can ensure we are committed to achieving our financial goals and exhibit the necessary action.
How much must be saved? A popular rule-of-thumb is that around 30 percent can be allocated for financial future items through saving, insurance and investments, while the remaining 70 percent can be for spending on needs and wants.
A written list of expenses and a written budget are valuable in giving us the visibility of how we handle money. Saving can be enhanced if we are able to distinguish between what we need and what we want. Needs are often related to basic food, shelter and clothing. The amount for needs can be optimized through practical living.
Wants make life more enjoyable but these can either be optimized or removed. Every peso saved is a peso earned. Reductions in needs and wants can be used to augment our savings.
Savings must be placed in financial instruments that are liquid. Examples can be bank savings accounts, short-term time deposits and short-term money market instruments. It is worthwhile to have a separate bank savings account for savings purposes. Easy access to savings is crucial when it comes to liquidity and emergency fund purposes. Placing savings in illiquid assets like real-estate assets is going to be impractical.
While saving as a first step is very important, it is obviously not the only step toward financial
freedom. The disadvantage of placing all of our money in liquid assets would be the reality that the returns on these assets usually are a lot lower than the inflation rate.
Hence, alongside the pursuit of achieving savings goals, preparations to beat inflation through the right investments are essential to maximize money. We must save not just because we want to save. We must save to eventually invest and grow our money.
Great things come from humble beginnings. Every solid structure needs a solid foundation. In the context of personal finance, the ability to save creates the first foundation of financial freedom. Saving based on clear goals and with resilient execution can lead us to the right path in securing a brighter future.
Gemmy Lontoc is a Registered Financial Planner of RFP Philippines.
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