Step 1: achieve a stable income to live off of. Step 2: save.
But how much? Where should you put that money? And what should you be saving for, exactly? Those are some of the most important questions to ask as you start your journey toward improving your financial situation.
We asked personal finance coach Kelly Harrell, founder of the Money Tree Academy, to help answer these crucial questions.
How much should I really be saving out of my paycheck?
A good framework for saving is to follow the 50/30/20 rule: assign 50% of your income to “needs” such as rent and groceries, 30% to “wants” like getting takeout or jeggings, and 20% to saving money and paying down debt.
Of course, a framework isn’t set in stone, and the 50/30/20 breakdown may work better when you tweak the percentages to suit your exact situation. For instance, 50% of your income may not be sufficient to cover required expenses, or you may consider assigning more than 20% of your income to particularly high credit card debt. If you find yourself in a situation with a lot of debt consider 50 (needs)/20 (wants)/30 (debt payments and savings).
If you have a two-income household
Kelly Harrell suggests a variation on the 50/30/20 rule if you have two wage earners in your family. One of those wage earners, she says, “should seek to have the basic, necessary expenses (housing, transportation, food) 100% covered.” So, if you think of a two-income household with each person earning roughly similar incomes, one of those earners covers 50% (the basic, necessary expenses). The second, she says, should aim to “only be used for discretionary expenses, retirement, and emergency savings goals.”
She also says that the long-term goal is “to have one income cover both necessary and discretionary expenses, with the second income going, exclusively, to retirement and emergency savings.” (Hey, we can dream.) Of course, that kind of savings is the ideal, and it’s easier said than done. But fear not, there are still ways to save.
If your family is a one-income household, you might want to follow a more traditional 50/30/20 framework—retrofitted for your family’s needs, of course!
By Percentage of Income
Your income level will affect how much you can and should save from each paycheck. What matters most is not your total household income but how your income compares to your expenses (your ratio).
If your income is just enough to cover your basic expenses, you may want to look for ways to either increase your income or decrease your expenses.
Ideally, income - expenses = a positive number.
So how do you know how much of your paycheck you should save? Track your expenses for at least one full month. Then break those expenses down into essential vs. discretionary costs and compare the amounts for each type of expense to your income for the month.
Let’s say your take-home household income is $3,000 per month, and you discover that your essential expenses are $2,500 per month. In that case, 83% of your paycheck is going towards basic expenses, leaving you only 17% for both discretionary expenses and savings. A reasonable savings percentage in that situation is 5-10%, depending on how much you feel you need for those day-to-day fun expenses. Of course, if your essentially expenses are 83% of your paycheck, we recommend examining where you might be able to cut those expenses back.
If your non-discretionary expenses are $2,500 but your household income totals $6,000, you’re only spending about 42% of your paycheck on basic expenses. That gives you some extra funds to toss into savings every month. You could reasonably save 25% of your paycheck in that scenario and still have a comfortable sum for discretionary costs.
Check out the Simple Guide to Family Budgeting to get more ideas about how to budget for your family “how to budget for your family”)!
What should I be saving for?
Building an emergency savings fund is an important savings goal. It makes it possible for you to keep paying your basic, necessary expenses for a period of time should an issue — job loss, medical emergency — arise.
Most personal finance experts will suggest that you have a certain number of months’ worth of expenses covered in your savings account. Three months’ worth of expenses is a good start, while having six months’ worth of expenses tucked away is a great long-term goal. If you rely on “gig economy” work (like Lyft or DoorDash), have an inconsistent income, or have a lot of dependents, you may want to target saving 12 months’ worth of expenses as your ultimate emergency savings goal.
Remember, the amount you save is based on required expenses, not discretionary ones.
Depending on your emergency savings goal, you’ll want to adjust how much you save from each paycheck.
Kelly says, “There is no one-size-fits-all savings amount, only general suggestions. Individuals should always factor in the stability of their employment situation.”
The higher your emergency savings goal, the more you may want to save from each paycheck. For example, if you’re self-employed or your entire household depends on a single source of income, you may want to save more than 20% from each paycheck by cutting back on discretionary expenses for a few months — at least until you have three months’ worth of expenses saved.
What do I save for if I already have an emergency fund?
Once you have three months’ worth of expenses tucked away, you may choose to shift some or all of that money you’re saving from your paycheck towards other goals. It’s a good idea to channel at least part of your savings towards retirement, while the rest can go to personalized savings goals that will help you accomplish your dreams.
Think hard about your goals. Do you have a dream vacation? Hoping to pay off your student loans? Investing in better tools for your trade? Prioritize your biggest, or most immediate goals, and save for them first.
How to adjust your savings plan
As you hit various savings goals, you can change your savings plan to match your new financial situation. Kelly says she encourages her clients
“to develop three spending plans:
- basic, necessary expenses,
- necessary, plus discretionary expenses,
- dream expenses (necessary and discretionary, plus expenses for dream goals).”
Then pick which plan to use as a budget based on how urgent it is to build up your savings. For example, if you don’t have an emergency savings and your job situation is precarious, you’d probably want to use plan #1: spend only on the necessities and save everything else. If you have no savings but have a very secure source of income, you might elect plan #2 instead.
Once you’ve reached your emergency fund goal, you may continue building your savings, but you could allow yourself more discretionary expenses. If you participate in a workplace retirement savings plan and your employer offers a matching contribution, then you may also want to contribute enough to max out that employer match.
Finally, when your emergency fund has hit your predetermined goal, you can switch your savings plan to accommodate your other goals. Some people consider this a good time to hike up your retirement savings; putting 10-15% of your paycheck into retirement accounts is a great goal (more if you’re approaching retirement age and have little to nothing saved for this purpose). The rest of your savings can go towards your personal goals, whether that’s to buy a house, pay off your student loan, or go on your dream vacation.
Where should I keep my savings?
A good place for your savings may, not surprisingly, be an interest bearing account. Keeping your savings separate from your day-to-day spending money makes it far easier to track how much you’ve managed to set aside. It also means you won’t accidentally spend some of that precious savings to pay for basic expenses. Finally, earning a little interest is a nice way to boost your savings.
Your non-retirement savings can go into any number of different types of interest-bearing accounts and financial products, from the regular savings account offered by many banks to high-yield checking accounts, CDs, money market accounts, and more. The best product for you will vary depending on your savings goals and needs.
For example, CDs can have excellent returns, but only if you leave the money in the account until the CD matures. This makes CDs a good choice for long-term savings goals but not for your emergency fund, which should remain easily accessible.
Once you take care of basic emergency savings, you’ll have multiple savings goals. In most cases, the solution is to set up multiple interest bearing accounts — one for emergency savings and another for other savings. This can make managing your savings a bit trickier, though, and can also limit the amount of interest you get because some banks require you to have a certain balance in a savings account in order to earn the highest possible rate of interest.
Start saving with the Protected Goals Account
That’s why Simple developed the Protected Goals Account. This is a high-yield checking account (meaning it pays a high rate of interest compared to the market average) that you can use to assign your savings to both a Savings Goal and an Emergency Fund Goal. After you open a Simple Checking Account, setting up your own Protected Goals Account is fast and easy, too. And anything that makes saving money easier is a good thing!
Kelly Harrell is the creator of for Money Tree Academy, a resource for women-focused financial tips and coaching.
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