Budgeting can be like dieting. At first you are super enthusiastic and ready to conquer the world, however, after a couple of days you’re pretty checked out and already ate some ice cream. That said, a lot of fitness gurus will say that they don’t diet but rather they live a healthy lifestyle. Well, how do we translate that into budgeting? Having a strong and consistent savings rate.
Your savings rate is your annual amount saved divided by your annual income, then just multiply it by 100 to get the percentage.
Your annual amount saved can count as many things. For example, this could be the amount actually in your savings account, retirement accounts, brokerage accounts, extra money put towards a mortgage, etc.
Many financial planners will tell you that a healthy savings rate is between 10-15%. While it is great to be saving anything at all, it is often best to challenge yourself to save the most money you can. After all, you worked so hard for your money – why put it in someone else’s pocket?
The goal with budgeting is to in the end, have a higher savings rate. However, more often than not we hear motivation speakers and successful entrepreneurs to begin with the end in mind. So why don’t we take that advice and utilize it while budgeting?
Set Your Savings Rate
If the goal of budgeting is to have a higher savings rate, why don’t we set what we would like our savings rate to be and then budget around that. Let’s walk through an example:
You make $40,000 annually. Note that taxes are not factored into the example.
You save $6,000 in your Roth IRA and another $3,000 in your employer sponsored 401k. You have saved up $2,000 in your savings account.
Your savings rate is current ((6,000 + 3,000 + 2,000)/40,000 )) x 100 = 27.5%. While this savings rate is great, you really want to work towards saving 35%.
So if we assume your annual income stays at $40,000, how much money do you need to save annually to be saving 35%?
Let’s use the same formula as above to back out what the amount needed is.
35% / 100 = 0.35 x 40,000 = $14,000
What the formula above shows us is that this example would need to save $14,000 annually to have a savings rate of 35%.
By approaching your budget this way, you know the exact amount you need to have saved across all of your accounts by the end of the year. This way, you don’t have to stress out about where every single penny is going and perform the “zero-based budgeting method” monthly, which can take up hours of your time.
Instead, you are looking at your budget from the CEO perspective, or at a much higher level. This mindset also encourages you to “not sweat the small stuff”. Look at your budget, what are the big hitters that are poorly affecting your savings rate? Is your goal savings rate attainable?
Budgeting doesn’t have to be as hard as it always is. By working backward and setting a savings rate goal to works towards, you are saving yourself hours of time and stress. Try out this method of budgeting and be sure to get back to us in the comments on how it worked for you!