- Saving consistently is the key to financial independence
- Auto-transfer at the beginning of each month
- Increase savings 1% per month until it hurts then stop
- Research the interest rates
- Emergency fund provides a buffer zone
Saving is the cornerstone to financial independence; if you are not saving on a regular basis, then getting to your financial independence goal will be very, very difficult. Ideally, you want to save consistently and until it hurts.
My approach is to set up a direct debit that will take an amount of money out of my bank account at the beginning of each month and direct it into my investment account and emergency fund. Once I have enough in my emergency fund then I will push all savings to my investment account.
As I became more comfortable with my savings rate, I then started increasing it, just by 1% per month. So this was easy at the beginning, let’s say I was saving €300, adding 1% just pushed it to €303. The next month it went to €306, then €309, etc…until I got to a point where my account was almost depleted at the end of the month. At that point, I held it steady.
When I got a raise at the beginning of the year, I waited to see how much my net income increased by and added that to the savings. The way I looked at it was that I didn’t need that money before then why should I start spending it now.
Every additional €100 saving per month that I put into the investment account should get me about €32,000 in 15 years based on 7% growth * annually. Of course, fees will have to be taken into account. The fees on the “iShares Core S&P 500 UCITS ETF” is .07%. Taking the fees into account would drop the annualised rate to a little over 6% and would give a return of €29,300. Still a good return considering you would have invested €18,000.
* 7% is based on the average return of the S&P 500 over a ten year period ending Dec 31, 2012 and that included the 2008 dip. I know, I know! past returns cannot dictate future returns but that is all we can go by for now until I invent the future viewing machine.
Pay Yourself First
If you have read, Rich Dad, Poor Dad, you would know about this concept; Pay Yourself First. This is a great way to budget your money. When you automatically set aside money each month then you have to budget your expenses with the remaining money. After a while, you won’t even miss the money that you are saving, you will find that you can get by without it. My budget covers all my necessary expenses and my reduced discretionary spend each month; my blind consumerism days are over.
Watch the Interest Rate!
Be careful about having too much money in a savings account (emergency fund). Interest rates on saving accounts are usually very low. If the interest rate that the bank is offering is lower than inflation then you would be losing money each year. As of April 2019, inflation rate in Ireland was 1.7%. So, if the savings account is paying 1.5% minus Deposit Interest Retention Tax (DIRT) tax, your money will be worth less when you pull it out than when you put it in. However, you do want to keep some liquid money at hand for emergencies so this is probably the best place for it.
Inflation is a natural increase in the cost of overall products over time. Think about how much shopping you could have bought 10 years ago with 100 Euros versus how much you can get now with 100 Euros. You are getting fewer items now because those items costs more. So having 100 Euros sitting in a savings account for 10 years will be worth less at the end of 10 years.
In the financial independence world, we save for two main purposes; either for investment purposes or for an emergency fund. I currently save for both together but you can save for one first and then the other, It will depend on your own preferences. If you feel more secure having, three months of an emergency fund then save for that first. If you are OK with slowly saving that emergency fund then try putting 50% of your savings in the emergency fund and the other 50% in investments.
One you have enough in your emergency fund then you can switch to 100% of your savings into your investment fund. For example, let’s say that you want 3 months expenses in your emergency fund, once you have saved this amount then change your direct debit to push the savings into your investment account. If you do take money out of your fund for whatever reason, just switch your direct debits again to top up that account.
It’s important to have an emergency fund in cases when you do need to spend money for an emergency such as car repair. You don’t want to have to sell your investments to cover this set-back. As the investment could be at the low point at the time and you could end up losing money. Having an emergency fund will help to keep that buffer zone of safety. Some people say you should have 6 months emergency fund but I believe that is too much money to have tied up in a low interest savings account when it could be working for me and making me extra money in an investment account. Again, this is up to you it will depend on what you are comfortable with 3 months or 6 months.
Do your own due diligence, get financial advice before investing in anything. I am not a financial adviser nor do I give advice in any fashion.