Today, we will focus on a key driver of Financial Independence – your ‘Savings Rate’. Put simply, it is the portion of your income that you don't spend, usually expressed as a percentage. If you deduct your expenses from your income, what you’re left with is your savings. Divide that by your income, and you've got your savings rate: (Income - Expenses) / Income. Your savings rate is arguably one of the most important components of your financial plan. It's what you have the most control over. You have little to no control over market returns, but you do have full control over how much you earn, spend, and save.
Financial Independence hinges on three factors: earning more, spending less, and maximizing investment returns. Your savings rate addresses two of these factors: earning and spending. As your income rises (without increasing expenses), your savings rate climbs. Conversely, by reducing expenses (without decreasing income), your savings rate also increases. The higher your savings rate, the quicker you can achieve Financial Independence. However, you shouldn’t decrease your expenses to a level that makes you feel deprived or gets you into a lifestyle that is not sustainable.
The 50-30-20 budgeting rule can guide you in determining your savings target. Allocate 50% of your income to necessities, 30% to discretionary spending, and reserve 20% for savings and investments. Admittedly, there may be times when setting aside a fifth of your paycheck seems daunting, and that's okay. Use the budgeting rule as a flexible guideline based on your circumstances. Whether you save 20% or just 2%, starting with any amount is better than nothing. Establishing the habit of consistently putting money away is the most important takeaway.
Saving money offers undeniable benefits – it fosters financial security, enables you to take calculated risks with less anxiety, and affords you the freedom to live life on your terms. On average, it is advised to build an emergency fund covering at least 3 to 6 months’ worth of living expenses. Once this is achieved, you can then channel your savings into a tax-advantaged investment account to leverage compound interest. Investing is taking saving a step further; saving is the starting point of investing.
I encourage you to make saving a priority, aiming to gradually increase your savings rate. Start small, save regularly, and incrementally increase your contributions. Saving money may require considerable effort for some individuals. However, I can assure you that making a conscious effort to cultivate the habit of saving is incredibly rewarding. Remember, most wealthy individuals reached their status through a combination of hard work, prudent saving, and wise investment decisions. Save a little, until you can save a lot!
About Nike
Oyenike Adetoye (aka Nike) is an impactful speaker, author, and personal finance expert. A Chartered Management Accountant by profession. Nike is the founder and CEO of LifTED Finance, a private financial firm that educates, coaches and supports people on their journey through financial fitness and wealth management.