How to manage your money like a pro
Today’s post is a guest post from our friends at The Finance Twins. Subscribe to their amazing blog to hear more about the basics of personal finance and how to use money as a tool to improve your life.
Focus on the things that matter most to manage your money like a pro
For most people, money is stressful. I know it used to be that way for me. But I guess that comes with the territory when you grow up poor. It wasn’t easy growing up in poverty, and it definitely was an uphill battle to build a healthy relationship with money.
I learned a few things along the way. In fact, I thought business degrees from the best business schools in the world (Harvard MBA and Wharton bachelor’s degree) would teach me the secrets to becoming wealthy.
What I learned is that most important things in life are often the most obvious. So, if your goal is to secure financial independence, the recipe is pretty simple.
Focus on maximizing two things:
A) Your personal savings rate
B) Your earning potential
I have a secret for you: If you maximize how much you can save and reach your full earning potential you’ll be wealthy. Wealthier than you ever imagined.
But if the formula is that simple, why aren’t we all rich?
Well, to start, if you are reading this I venture to guess that you don’t have a budget. If you do, you probably don’t stick to it. That’s because saving money is hard.
We Live In A World With Expensive Distractions At Every Corner
Simply take a look at the annual calendar and you’ll realize there’s never a break!
In January, you’re spending money on gym memberships and other New Year’s distractions. You hit February and you’re talking about Valentine’s Day and maybe a ski trip or a vacation somewhere a bit warmer. It’s also a short month so maybe you get paid less. March means spring break or other fun excuses to spend as you begin to look forward to spring. April brings Easter and other holidays. Maybe you’ll be preparing a big family celebration or traveling to be with loved ones. Memorial Day weekend is essentially an excuse to see how much money you can spend on a BBQ cookout in May. June - August are the summer months where fun seems to be more important than saving money.
Back to school season already? Yep, It’s September. That means clothes for the kids, new work clothes for you. Maybe the sales entice you to buy things you don’t even need. October brings Halloween parties and November is Thanksgiving. December is the granddaddy of them all with the full holiday season where your wallet seems to get thinner as your waist expands.
Simply thinking about the annual spending calendar is mentally draining.
Is It Even Possible To Save?
How is anyone supposed to save in a consumer-driven environment like the one we share?
Well for one, you need to be extremely committed to it. If you don’t prioritize saving, it’s never going to happen. Even if you get paid incredible sums of money. I used to work on Wall Street with colleagues who earned 7 figures and they’d still find ways to spend all of it. ALL OF IT.
To get ahead, you need to learn how to budget. You don’t need fancy software. Just an easy template and time. At the end of the day, your budget is simply your report card that will tell you how you are doing. The only metric that ultimately matters is your personal savings rate. This simply shows you what % of your take-home pay you are actually able to save on a monthly basis.
If you are single or live in a single-income household, aim for 30% of your take-home pay. If you are married, have a spouse or partner, and both of you work, aim for a savings rate of 40-50%. If you both earn a similar amount, simple live off of one of your wages and save the other. If one person earns more, try to live off of the higher wage if possible.
It’s simply less expensive to live with a partner which is why the goal savings % is higher.
Are there any secret formulas for saving money?
The most important thing is to keep your major expenses low (rent or mortgage, car, and healthcare). If you keep those things low, you’ll give yourself a lot of freedom.
Secondly, shop around for the best prices for things you buy regularly. For example, you can use Contacts Compare to easily compare contact lens prices and save money. Do the same thing for paper towels, toilet paper, and other things you use regularly. Those things will add up.
Another tip is to update your W4 form at work so that you don’t have too much tax collected. Over time you’ll pay the same amount in taxes, but you’ll be the one holding onto your money which means you can put it in a high interest savings account and earn something on it!
Having A Huge Savings Rate (e.g. 60%) Is Irrelevant If You Aren’t Earning Enough
If you’re thinking, “wow, I am able to save 30% of my income so I am set for life!’, reign yourself in for a second.
The sober truth is that having a high savings rate doesn’t matter if you aren’t earning to your full potential. 50% of $50,000 is $25,000. So you’d be better off saving 30% of $100,000 since that is $30,000.
And no, I don’t mean that you should quit your job right now because it doesn’t pay enough. If you love your job but it doesn’t pay well, you need to seek other avenues for income growth. Maybe that means asking for a raise, switching companies for more money or turning a hobby into a side hustle.
We’ve all heard the stat that the average millionaire has an average of 7 different streams of income. Who knows where that started or if it’s true, but I can tell you from experience that I have more sources of income now than I did at my first job.
For one, I know earn money off of my investments via stock dividends. It’s not a ton, but it adds up over time. I also run my own company so in addition to a wage, I am “earning” the equity growth. Lastly, I do a bit of freelance writing for Forbes and other publications for extra cash.
You talk about maximizing your savings rate and earnings, but what about investing?
Most people aren’t going to get rich by picking the right investments. It’s the simple truth.
For example, let’s pretend you are an amazing investor but you suck at saving money. If you had $10,000 and were able to earn a 13% annual return on your money, you’d have a whopping $391K at the end of 30 years. A 13% annual return over a 30 year period would make you one of the top investors in the entire world. The top 1% of the top 1% of investors! Over a period of 30 years you grew your money by 3,812%!!
The only problem is that you sucked at saving and didn’t put away any extra money.
On the other extreme, let’s pretend you were INCREDIBLE at saving money but were a horrendous investor. You earn $50,000 per year and are able to save $25K annually. However, since you suck at investing you just keep your cash in a checking account earning basically nothing in interest. Even though you don’t invest, your $25K saved annually will add up to $500K after only 20 years!!
That is way better than the clown who invested like a champ but saved like a chump!!
All this is meant to highlight is that if you are able to keep your savings rate up, and reach your full earning potential you’ll be able to amass tremendous wealth with a boring investment strategy.
I keep all of my money invested in index funds. Index funds are basically a collection of stocks and bonds so that my portfolio mimics the entire stock market. If the market goes up, I make money. If the market drops I lose money. The same isn’t true for people who pick individual stocks, since they could lose money even if the market goes up as a whole.
My site has details on everything you need to know about index funds.
Don’t get distracted by Bitcoin or the next greatest investment. They are simply distractions keeping you from focusing on the two things that matter most. You probably already knew that those 2 things were the most important.
Like most things in life, it’s easier said than done.