Saturday, July 23, 2011

Budget Discussion -- Part 4 "Savings Rate"

It's been a while since I discussed anything related to personal finance. Part of the reason is that my own budget management has been in flux, with all the moving expenses and everything. For instance, I will have to be changing the license plates on my car soon (which will cost a pretty penny). But I thought I'd share an important topic in this post related to personal finance: savings and savings rate.

At a time where unemployment rates is increasing and government support programs like Social Security and Medicare are facing cuts, personal savings is extremely important to have financial stability. This is particularly relevant for young professionals, who are nowhere near the age nor the particular situation that warrant applying for government assistance. Nor should you consider government assistance programs such as food stamps as anything but the last resort -- when all other venues for financial support have been exhausted. It is incredibly damaging to own's self-esteem and psyche to receive government aid.

So where do we begin? I am not going to espouse anything along the lines of a recommended amount you should be saving per month. Savings are highly subjective: depending on your spending patterns and any situations that might arise. Therefore, throwing a number out there isn't helpful -- more so as everyone likely has different income levels. But for starters, saving something is better than saving nothing. I have a difficult understanding people who insist on spending every last dollar they earn in the form of end-of-the-month splurges. One should not live a life rife with worries over finances, yet it does not make sense to save nothing.

Working with the premise that we ought to save something, I believe the next step to sound fiscal management is to consider your paycheck (as opposed to the wage rate) in percentages. In other words, start to think your spending as percentages of your paycheck. Case in point: if you earn $2,000 per month and pay $500 for rent, then rent is 25% of your personal revenue. This way, it is much easier to practice budget management by limiting a certain category (e.g. food) to a particular percentage. We can also better establish gauge the amount of every paycheck we can be saving -- by transforming into a percentage.

To better illustrate my point, I will provide a mock example of the revenues vs expenses for an individual on a monthly basis:
  • Income (in-your-pocket) -- $2,000 per month
  • Housing -- $500 per month (or 25% of income)
  • Food -- $400 per month (or 20% of income)
  • Transportation -- $100 per month (or 5% of income)
  • Entertainment-- $400 per month (or 20% of income)
From the above example, one can see that if the planned budget holds, then this individual will have $600 left to spend. Percentage-wise, this is 30% (100-25-20-5-20), which is a phenomenal savings rate. More realistically, a savings rate would probably be between 10-20% due to individual preferences (e.g. housing probably is 30-40% of income). This is still very good if you can hold to it. The best part of thinking expenses as percentages of income is the leeway it provides for future tinkering. It allows someone to take a look at where income is being spent on and adjust if a certain category is taking up too high a percentage.

Personally, I have an abnormal savings rate of (considerably) more than 30%. This may be shocking but it's less surprising if you consider the spending patterns and quirks (e.g. shopping on Craigslist) discussed before. Cooking and packing lunches are also very helpful to bring down the percentage allocated to food costs.

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