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This is the penultimate post in our FI Basics series. If you are already very familiar with basic financial independence (FI) concepts, you may want to give this one a skip. The two most recent posts focused on Spending and Setting your FI Target. Today, we’ll focus on saving. I’ll walk you through common FI approaches for creating savings, securing your savings, and how to best deploy your savings to work for you.
How do I create more savings?
Savings = income – spending
This is pretty straightforward, right? You can increase your savings by increasing your income and/or decreasing your spending. If you do both, you are supercharging your savings rate!
I can’t just magically increase my income!
Actually, you can. Well, maybe not by magic but by intentional effort and choices. You can also review your options, and choose not to increase your income. Either way, take agency and realize that it is, at least partially, within your control.
Climb the Career Ladder
In whatever career you’ve chosen, there is likely some form of upward mobility for income. This may require gaining experience, education, time, or even the dreaded politics.
For educators, there is a wage ladder based on role and education attainment in most districts. A rough example looks like this:
- Educational assistant – $15 /hour
- Substitute teacher – $150 /day
- Classroom teacher – $45,000 /year
- Classroom teacher w/ time and Masters Degree – $60,000 /year
- Principal – $90,000 /year
Each of these roles are important and valuable to schools. (Income does not denote worth) People choose a role for different reasons. However, income can be one factor in your choice of job.
There are similar examples in almost every profession.
If you look at your career ladder and are unhappy with the income options in your current career, you can choose to work in a different field entirely. Make sure you do your research on educational requirements and factor in any lost income during your transition. If you move to a job that increases your income by $10,000/year but it takes $30,000 and two years of lost income, it may not be worth it.
I’m passionate about education, so I chose to work the ladder rather than switch entirely. In fact, I stepped down from a higher earning career path into education.
Geoarbitrage (moving for economic advantage)
In many fields, your income is vastly different depending on where in the country you work. To illustrate, Nicholas Ferroni recently started this discussion on Twitter:
The results were stunning. Even more variance than I expected. Teachers with similar experience were earning as little as $38,000 and as much as $90,000. You can choose to move to achieve a higher income. It appears that a move from the South to the West Coast would dramatically increase your income.
Be sure to factor in cost-of-living differences before assuming a higher income is always better. Often urban areas pay more, but housing costs are significantly higher. If you are looking purely to maximize your income, states with high-paying urban areas often have more remote areas where wages have been pulled upward by the more populous areas of the state.
In some careers, there are incentives to fill critical positions (doctors and educators in particular) in remote or rural areas. Investigate your options.
You can augment your income by taking on additional work. Sometimes this is just a second job where you work for a different employer. Other times it may be a short-term task, self-employment, or product to create additional income. Both of these tend to get lumped together, but the latter is what I consider a “side hustle.”
There is significant information out there about side hustle possibilities for virtually anyone. Side Hustle Nation is a great place to start.
Educators actually have many great options for side hustles due to their specific skills and education. I’ll detail these in a later post.
As I’ve mentioned before, reducing spending is the most powerful step you can take in FI planning. Here, we’ll focus on how to use it to create additional savings.
When people think of reducing spending, they often think of things like reducing daily Starbucks visits, not buying designer labels, or cutting out expensive dinners out. The easiest step to take is targeting those obvious “extra” expenditures.
If you are currently an overspender, you will see instant gains here. For many, however, this will not be enough to really accelerate your journey to financial independence.
As a first step, these are important. By all means, create savings by reducing the easy extras.
For Real Gains, Focus on The Big 3
Despite what we often believe, the vast majority of spending doesn’t go to those “extra items.” In fact, the latest release from the Bureau of Labor and Statistics demonstrates that the “big 3” continue to account for almost two-thirds of spending.
Housing – 33.1% of average household spending
Housing costs are, by far, the most significant single component in American spending. We love our houses. If you are building a path to FI, you must limit the amount you spend on housing.
Ignoring, for now, the debate about renting or buying – choose the cheapest living condition that works for you.
On the extreme end, you may choose to share housing with multiple roommates, live in a tiny house, or move into an RV. Reducing housing costs drastically is powerful. These may not be realistic options for you.
At the very least, you should avoid buying more house than you need simply because you can afford it. The conventional wisdom says you should spend 30% of your income on your housing. The average of 33.1% is higher than that. Both are higher than necessary in most cases.
If you live in a high housing cost area, geoarbitrage (moving to a different region) can be a strategy to reduce spending, too.
The lower you can push your housing cost percentage, the more savings you create.
Transportation – 15.9% of average household spending
Similar to housing, this is another area where Americans are pushed into the overspending trap. There are some obvious things to avoid: (Does anyone actually buy a Lexus as a Christmas gift?! )
As with housing, you should avoid the typical consumption traps with cars. Do not buy more than you need, or push up to a luxury brand for status.
The options for lowering your transportation costs range from extreme lifestyle change to simple adjustments. Here are some options:
- Move closer to your work. This will allow you to walk and/or reduce gasoline costs
- Go carless. Bike everywhere / use public transportation.
- Reduce to a single family car.
- Bike commute as often as you can.
- Buy used cars.
- Keep cars longer.
As with housing, you can adjust to fit your plans and lifestyle. My work requires frequent driving. I chose to buy new and drive it until it’s done. However, I also bike commute when possible to reduce costs. I do not buy luxury brands.
The average is 15% of income spent on transportation. You can do better.
Food – 12.8% average household spending
More than 10% of income on food alone! I was shocked when I learned this. I was even more shocked when I saw how high our food spending was after we tracked our spending for three months.
We all have to eat – so please don’t reduce this to zero. (Yes, even growing your own food has costs…)
Common ways to create savings in the food category:
- Reducing/eliminating meals out
- Shopping at lower cost stores
- Meal planning/prepping (Planning meals in advance to reduce waste and maximize bulk buying)
This is definitely an area to target in our household. In the coming year, it’s even one of our FI goals!
Targeting the big 3 will lead to your most significant savings. Never stop looking for opportunities in all areas of spending.
Health care is the fourth largest expense area. This one is difficult to reduce and continues to be a challenge for financial independence in America. Explore your options, but don’t leave yourself in a bad situation. Your health is more important than money. I hope we’ll create a
Small expenses that repeat every month are another area to target to create savings. Look for monthly subscriptions that can be reduced or eliminated. Do you really read that magazine? Can you accept a lower tier of cable? Are you paying for something that you haven’t used in a long time? Review your spending and reduce these wherever possible. A $10 monthly reduction adds up quickly.
How can I trick myself into reducing my spending?
The most effective way to reduce your spending is to take away your own money before you can spend it!
Sometimes this is termed “paying yourself first” and framed as increasing your investing. It does. We, however, have used it to both reduce our current spending AND prevent lifestyle creep. You can do this too – it’s powerful!
Once you know your required spending, simply make sure everything else goes into savings automatically. This can be through auto-investments at work or bank transfers to savings accounts. Should your circumstances shift you can change the withdrawals. Until then, you’ve limited the amount of money you perceive as being “available.”
If you want to achieve a 50% savings rate, only give yourself access to 50% of your income. Adjust accordingly for your preferred target.
Where should I secure my savings?
Now that you’ve created savings, what do you do with it?
The vast majority of it will be deployed to work for you. But first, you should take two steps to guard against short-term destruction of your FI plan.
Make sure you keep enough money in a savings account, attached to your bank, to ensure that you are always paying off your monthly debts. This is especially critical if you use credit cards.
Two sunk costs that will slow your path to FI are overdraft fees and credit card interest. Until you are completely sure that you’ve got your spending dialed in, keep a savings account stocked.
Be aware that most bank savings accounts pay little, or even zero, interest. Keep only enough in the account to ensure protection from these pitfalls. We set an amount for this account, and then each month automatically remove anything extra into investments.
Emergency (Security) Fund
Build up enough savings to cover 3 – 6 months of your monthly expenses. Some recommend as high as 12 months. I believe most on the path to FI are more aware of finances and can be flexible enough to land on the lower end of recommendations. Choose your own level of comfort.
This account is to protect against unforeseen shocks and provide you time to recover. Examples include job loss and a high-cost medical emergency.
This is not for things like new car purchases. If you are planning on a large purchase, save that in a separate one-time sinking fund while continuing to maintain an emergency fund.
Your emergency fund will be a larger pot of savings and should be accessed rarely, if ever. Therefore, place it in a higher interest account. You can apply for online savings accounts that are currently paying you 2% or higher interest. Here is a list at Nerdwallet.
We maintain 4 months of expenses in an online Discover account. We chose this for ease of use, a solid app, competitive rate, and signup bonus. Ally is another popular option.
How do I deploy my savings?
Once you have created savings and secured the appropriate amount in an emergency fund, you are ready to start making money work for you.
Do not simply accumulate money in a savings account. You will lose ground to inflation. Costs will increase faster than the interest you earn. You will actually have less spending power over time. This also applies to burying it in your backyard or on a pirate island.
Instead, think of the savings you have created as an asset you can deploy to grow itself. Your savings becomes a valuable tool to accelerate your wealth accumulation and power your FI journey.
Your savings from this point forward will be invested! Now, your FI journey speeds up.
In the next, and final, installment of the FI Basics series, we’ll cover the basics of investing for financial freedom. We’ll discuss risk, tax-advantaged investments (which also helps increase your savings rate), and common FI investment choices. Subscribe here to join our growing community of educators pursuing financial independence.
I want you to be financially independent!
Update: Here is the index of the entire FI Basics Series if you’d like to hop around other posts in the series:
- Financial Independence Primer
- Dealing with Debt
- Sort Your Spending to Speed Your Journey
- Two Powerful Numbers to Track
- Setting Your FI Targets – How will you know when you are financially independent?
- Strategic Savings: Create, Secure, Deploy(You are Here)
- Investing: 5 Keys and 2 Examples