Saving money can be really difficult. That’s why a full 2/3 of US households can’t cover a $1,000 emergency. I’ve read hundreds of articles (and written a few) that talk about saving money by switching out your light bulbs, switching phone carriers, and of course skipping that morning latte at Starbucks. While these are all good ideas, they are concentrating on areas of the budget that don’t make up a large percent of total spending. These changes might get you from saving 5% of your income to saving 6 – 7% of your income, but they won’t get you to 40% or 50%. There are 5 areas of our lives that effect our savings rate the most. If we can control these five things, saving money will become ridiculously easy.
1. You Can’t Save Money Because of Housing Expenses:
What American’s spend on housing is absolutely insane. The median house in the U.S. is $188,900. That’s median, not average, meaning that half of houses sold sell for above that amount and half for below that amount.
As an example, let’s say you earn $50,000 per year. The bank says that your house payment with taxes and insurance can be 36% of your gross income. That’s $18,000 per year or $1,500 per month. A $250,000 30 year mortgage at a 4% interest rate has a payment of roughly $1,200. Add in $200 per month for taxes and $100 per month for insurance and you’ve reached the $1,500 per month the bank suggests you should spend on a home. I think that a $250,000 house for someone earning $50,000 is way too much.
I suggest that this number should be kept to 15% of your income and with a loan of no longer than 20 years. That’s $7,500 per year or $625 per month. An $85,000 20 year mortgage at 4% is $515 per month. Since the house is much less expensive, equivalent taxes would be around $70 per month and insurance would be around $35 per month, this brings the total price to $620.
Buying a house will most likely be the most expensive single purchase you ever make. If you are already in a house that is a huge percentage of your income seriously consider downsizing to move forward in life. Spending over a third of your gross income on housing pretty much assures you that you won’t get ahead. Getting a home with an $85,000 mortgage over a $250,000 mortgage allows you to save $880 per month AND pay off the house a full decade sooner.
Just making this one decision accounts for someone earning $50,000 a year to save 21% of gross income!
2. You Can’t Save Money Because of Vehicle Expenses:
Have you seen Sprint’s new commercials that brag that their network has 99% of Verizon’s reliability, but for half the price? Image if you could get 99% of the reliability from a product, but for 10% of the price? That’s just what you can do with vehicle selection. You can get a very reliable used $3,000 car instead of a $30,000 new car. I’ve been driving my car that cost under $1,500 for 3 years now, with no substantial issues. Cars depreciate in value fast. Having money wrapped up in cars kills your ability to build wealth.
If you bought a $30,000 car with 10% down this would result in a $27,000 loan. A $27,000 loan at 3% over 5 years would carry a payment of $485 per month. Oh, and when you have a loan on a car you tend to pay higher insurance rates as well since you need to maintain full coverage insurance. That new car is now costing you $600 per month. I will agree that the $3,000 car will need more repairs and maintenance, but this will likely not exceed $100 per month, meaning that $500 per month is literally being thrown away by driving the new car. I recommend the total of all household vehicles be under 15% of yearly gross income, so for a family with a $50,000 annual income, the total for all vehicles would be a maximum of $7,500.
For someone earning $50,000 per year $500 per month represents 12% of gross pay.
Making just these two decisions allows you to save 33% of your income!
3. You Can’t Save Money Because of Taxes:
We pay a lot of taxes. Now statistics on how much the average person pays are really hard to come by because our tax law is filled with a myriad of deductions, credits, penalties, and fees. On average we pay 15.5% in Federal income tax, 15.3% for social security and medicaid (including employer contribution), and roughly 5% for state and local taxes. Oh, and there’s property taxes and sales taxes too, which are highly variable. For some people taxes are their largest expense and for most of us taxes are easily in the top 3.
The good news is there is a lot that we can do to reduce our tax burden. The easiest is contributing to tax advantaged accounts, such as 401K’s IRA’s and HSA’s. You will want to set up these contributions to be automatic, so you don’t have to think about them on a weekly basis.
If you are earning $50,000 per year and are in the 15% federal tax bracket and 5% state tax bracket, putting 25% of your income into retirement accounts would net you a tax saving of $2,500. If $6,750 of the $12,500 being saved in tax advantaged accounts goes into a family HSA plan through your employer, then you would save another 7.65% on taxes, as these contributions are also exempt from Social Security and Medicare tax. That’s a tax savings of $516. Just through applying the savings you made by owning a less expensive house and a less expensive car, you will save an extra $3,000 per year, a full 6% of gross income.
We’re now up to saving 39% of gross income without much effort.
(That’s also assuming your employer doesn’t offer a 401K match. An employer offering a 50 cents per dollar match for the first 5% would add 2.5% to your gross savings rate.)
4. You Can’t Save Money Because of Insurance Expenses:
American’s buy a lot of insurance. Health, Car, Home, Life. When is the last time you looked at the details of all of these policies you have? For health insurance for me personally the difference between a traditional health plan and a high deductible health plan was around $150 per month. Of course there are many factors that determine what the right health plan for you will be and what the difference in cost between plans will be.
Car and home insurance is another place where you can find some decent savings. Of course you want to have your vehicles and your house on the same policy to get multi-policy discounts but there are also several other ways to save money on these policies. By paying in full every 6 months, waiving full coverage, choosing a high deductible, and being claim free for multiple years can greatly reduce your insurance costs. Some people balk at having a high deductible, but once you are able to save a higher percentage of your income, your emergency fund will grow quickly to be able to cover any deductibles you have. An often overlooked discount is reducing your home rebuild policy from 100% to 80%. In total it is entirely possible to save over $1,000 a year on your home and auto insurance.
Making these changes should get your savings rate up to around 45%.
5. You Can’t Save Money Because of Time Management:
I know a lot of people who think that it should be enough if they work 40 hours a week. The 40 hour work week is a standard feature in America, although on average we work 34.4 hours per week, which is actually high compared to other countries. We all get 168 hours every week and people who are willing to work more hours can get ahead in life a lot faster. If you currently work 40 hours per week and decide to work 50 hours per week, even if it’s without overtime, this will increase your gross pay by 25%.
Doing this combined with the above actions will allow you to save over 50% of your income. This means every year you work you are buying a year of time even without market gains. Most likely you will be financially independent in under 15 years. The best part is, you don’t have to live like a miser. You don’t have to constantly question whether or not you can/should buy a new pair of jeans, get dinner out on a hectic night, or take the kids on a fun vacation. If all these big things are taken care of, you will be able to save money without having to think about it all the time.
Bonus Reason Number 6: You Aren’t Getting Paid What You’re Worth
When was the last time you asked for a raise? It blows my mind how few people ask their employers to increase their pay. I’m no expert at negotiations, but I have been trying to learn and I have initiated MANY of these awkward conversations. Across 6 employers or potential employers, I have been successful in getting a substantial raise or offer from 4 of them, just by initiating a conversation, talking about what I have recently accomplished for the company, and what I can do for the company going forward. I ask how my boss would rate my performance and what he feels I would need to do to become more valuable to the company. I’ve received raises or increased offers from 4% up to 25% by having this conversation.
In one situation I had a potential employer offer me a $4 per hour increase in pay rate just by asking for another couple days to make my decision on whether or not to accept the job offer. If you can get a $4 per hour raise from 1 conversation, that equates to $8,000 per year, every year for the rest of your career. Recently I read “Getting to Yes: Negotiating Agreement Without Giving In” which gives extremely good advice on how to make negotiations move in your favor.
What do you think? Are you willing to make these changes to get ahead in life? What are the other reasons you can’t save money, and what actions can you take to change the situation?