Saving money (a realistic approach)
In recent times there has been a plethora of articles and web sites detailing how to save money and live on a shoestring budget. Unfortunately they tend to fall into one of two categories. The first one typically recommends cooking meals from scratch, growing your own food and utilizing household cleaners for all types of weird and wonderful jobs. The second type simply reiterates this information but charges you for it. So for those people out there who want to save money but not live in the 18th century then this article is for you.
Before we start I want to examine one of the more common myths out there regarding making money by the use of compound interest.
"If you have $5000 and invested it for 5 years at 10% interest you would end up with $8052!"
How many times have we heard such a statement? The reality unfortunately is quite different. Let me explain. Often the interest quoted is higher than what is currently available, so lets take a more realistic approach of 7%. Now 7% is still quite good but you didn't think you'd get all that extra money for free did you? After all the interest is considered income and is taxed in most countries. Even if the tax is only 20% that still reduces it to 5.6%
The effect of inflation also needs to be considered (the rising cost of food, petrol, housing etc). After all $5000 now buys a lot less than it did 100 years ago. If we take an inflation value of 2% that leaves us with 3.6% This means after 5 years we will have $5967 (in todays buying power) which is significantly less than the $8052 typically presented. It is these types of empty promises that litter the internet on sites devoted to making/saving money.
So how do we save money? There are three important things we need to do:
(1) - Maximize income
(2) - Minimize expenses
(3) - Eliminate expenses
The first step is to maximize income. This may mean additional overtime, asking for a raise, or even a part time job to supplement your weekly income. However for the majority of people this is not something that is likely to happen overnight so typically we will be relying on a known fixed income.
For the second step we need a list of all household expenses. I recommend doing this in a spreadsheet.
- Firstly create a list of weekly consumables (food, petrol, snacks, rent/mortgage etc)
- Add in the monthly expenses (electricity, phone, cellphone, internet, haircuts)
- Add in personnel expenses for each person (clothes, CD's, movies, gifts)
- Add longer term expenses (insurance, car registration, doctor/dentist visits, bank fees)
- Add in all debts
One you have done this you will need to group similar items together. For example car insurance, petrol and car registration would be grouped together. For each item listed work out how much you would pay per year. For example if you were spending $80 every three weeks for petrol that would amount to (52 * 80 / 3) = $1387 per year. Once you have done this sort the list by yearly cost. The purpose of this is to appreciate where your money is being spent. For example if you bought a $2 muffin each day at work this would add up to $520 per year.
At this point we are not looking at eliminating expenses, just minimizing them. For example buying fruit and vegetables that are in season, switching to a different bank for cheaper fees, shopping around for a cheaper power company. There are many ways of minimizing expenses and you should look carefully at each item on your list. Once you have done this you will now have an updated cheaper list.
By this stage you are probably thinking that this is the same thing that most cost saving web sites get you to do. This is true but this is also where we diverge from those sites.
The third stage is eliminating expenses. For this stage we are going to try a radical new approach. Imagine that you are locked in a room tied to a chair. Imagine that there is someone behind you holding a gun to your head. If you don't immediately eliminate 20% of your expenses he will pull the trigger. Although this is a somewhat extreme scenario it forces you to think about what is really important. After you have completed this exercise repeat the exercise again this time eliminating 40% then 60% then 80% of your expenses. At the 80% mark you may very well be renting a flat in the worst part of town (or maybe living in your car), barely scrapping by on food with no money for luxury items. However it forces you to prioritize exactly what you and your family need to survive. From here you should be able to find the best expense reduction point to help you save money. Just remember that there is very little a human being needs to have in order to survive. Often our judgement is clouded by what we want rather than what we need.
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