Sure, you understand the basic concept of saving. Put aside some money for an emergency; almost everyone gets that.
But if you’re like most people, you’ll realise that saving is like dieting: it’s easy to say and understand, but feels almost impossible to pull off.
Here’s how to make a savings plan that really works:
How much do you need to save anyway?
Aim to save 20 per cent of your monthly income, and to save until you have enough to cover six months of expenses. This will be your rainy-day fund.
Why six months? Well, if you get retrenched or become too sick to work, six months gives you time to recover financially. At the same time, you don’t want to go overboard, and save five years’ worth of your expenses – that’s because savings are not invested, and don’t keep pace with the rate of inflation, which currently stands at about 2.97 percent.
Which leads us to…
Differentiating your savings vs investments
You shouldn’t ever confuse your investments with your savings. Your savings fund is a fixed amount of money or liquid assets that you can access at a moment’s notice. This isn’t true for your investments, which could fall in value during an economic downturn.
If you invest in something like an endowment plan, or a bond, there’s always a maturity period, which means you’ll be in the red or in it for the long-run (e.g. planning for your future child’s education)as you’ll have to wait five, ten, or even 20 years before you can get money out of it. If you try to withdraw the money immediately, you’ll only get a fraction of it.
Besides getting less money than you expect, it could seriously mess up your retirement plans.
Instead, your savings should go somewhere secure and accessible, such as a separate savings account, or to Singapore Savings Bonds (SSBs). The interest rates are low, but don’t worry too much about that – your savings are meant to tide you over in hard times, not to grow your wealth.
If you also want to grow your wealth, you’ll have to invest while you save.
More on that in part five of our series ?.
How to sustain the savings plan
This is the hard bit. Saving takes a lot of self-control, and the human brain is really bad with keeping track of money. The good news is that there are plenty of easy ways to save in Singapore.
But, in the long-term, you might have to trick your frontal lobes into saving, and here’s how:
- Automate your savings
- Beware of Malleable Mental Accounting
- Limit your credit facilities
- Reach for your “tipping point”
- If you have debt, save while paying down the debt
Automate your savings
Use services like GIRO to wire your savings (20 per cent is a safe bet) to a separate bank account the moment it comes in. Trick your brain into thinking the money isn’t there. If you don’t see the money in the first place, you won’t spend it. Otherwise, you’ll be tempted to spend everything.
If you really want to get into it, this concept is rooted in ego depletion theory. Cognitive effort or willpower is a limited resource. You use a little bit of it all the time, such as to push yourself to exercise, to keep working, or to avoid spending money.
In stressful situations, it can quickly run out. That leads to phenomena like the infamous “retail therapy”, where you give in and spend the month’s savings on shoes, a new tablet, Hearthstone booster packs, etc.
Beware of Malleable Mental Accounting
Malleable Mental Accounting is a strange quirk of human psychology, where we assume an automatic relationship between lower expenses and higher savings.
Right now, you’re saying “wait, why aren’t they related?” and BAM, you’ve fallen for it.
Say you switch your telco, and pay SGD 60 a month instead of SGD 80 a month for your data plan. For most people, the reflexive action is to assume they’ve saved an added SGD 20 a month.
Due to Malleable Mental Accounting, a lot of people don’t actually bank it in. They congratulate themselves for ‘saving’ SGD 20 a month…and then go right ahead and spend that SGD 20 on extra Grab rides.
The same thing happens when shopping for frivolous buys. Say you buy a SGD 200 wireless charger, because it’s SGD 100 off, you’re sleep deprived, and this is what happens when you shop on Amazon at four in the morning.
Since the number of people on the planet who need a wireless charger is below one, you haven’t “saved” SGD 100 – you’ve just wasted SGD 200.
So, make sure that when you manage to lower the cost of something, you bank in the difference. And stop equating sales with savings – that’s just a marketing ploy.
Limit your credit facilities
The more credit facilities you have, the more temptation abounds. There’s no need to have ten credit cards, nine lines of credit, and more financing options than you can count.
To avoid temptation, close the credit accounts you don’t use to avoid temptation.
Reach for your “tipping point”
It isn’t true for everyone, but some people have a “tipping point”. This is the point at which saving becomes a habit, and not saving is harder to do.
For example, you may find that you so feel good after saving up SGD 5,000 that you just want to keep adding more to the stash. Looking at that money in your bank account can give you a positive kick, which makes subsequent saving even easier.
What’s more, if you have a proper savings fund, you won’t need to use high-interest credit, even in an emergency.
If you have debt, save while paying down the debt
You still need to save money (at least 10 per cent of your monthly income), even if you have debts to pay down. Otherwise, you could get trapped in a vicious cycle.
For example, say you owe SGD 5,000 in debt, and you’re eager to pay it off. Your monthly salary of SGD 5000 comes in, and you decide to blow SGD 5,000 to pay off all the debt at once. True, you’ll have to live off bugs and small animals you capture in the office parking lot, but at least all your debt is settled right?
Problem is, what happens if another unforeseen emergency comes along? What if a loved one needs surgery, or you get retrenched? You’ll have no cash reserves to deal with this, which leads to more loans and continued debt.
To break out of it, set aside some money for emergencies, even as you pay down your debt.