Chapter 2. Saving and Investing explained

As we learned in Chapter 1, your net income is an actual amount of money you can budget, whether it be spending, saving, or investing. Budgeting is a basic foundation required to become financially independent. Budgeting requires you to track essential expenses and monitor your spending habits. Doing so can help you control your money, create short and long term financial plans to meet your goals, and increase your financial confidence. 

How to

So how can we do budgeting? First, track your monthly expenses (you will learn more about it in Chapter 4) and pay yourself first. When you receive your paycheck, make a habit of putting a portion of earnings into savings. A good rule of thumb is to save at least 10% of your net income or more. You do not need to aim too high from the beginning. Rather it is more important to make a financial commitment you can practice consistently. 

In addition, open a separate emergency fund savings account. An emergency fund can protect you from urgent and unexpected expenses, such as car repairs, dental bills, or vet expenses that demand a large chunk of money. Sometimes, some people use credit cards in such occasions, but it should be noted that credit cards are essentially debts and may harm your credit score if managed poorly. Also, emergency funds should not be easily accessible. In other words, you should not use emergency funds to make purchases for non-emergency occasions, such as concert tickets or high-end clothing. We generally recommend that you save 3-6 months worth of your essential expenses as the emergency fund. 

 A simple but ideal way to budget is to follow the so-called 50/30/20 rule. It guides you to limit your needs (e.g., groceries, housing, insurance) to about 50% of your net income. Also, limit your wants (e.g., eating out, shopping, leisure) to 30% of your budget. Lastly, allocate up to 20% of your budget for savings and other financial priorities such as credit card repayment and emergency fund. Following this rule as a guide to create and meet your budget plan helps you maintain a healthy saving and spending habit. 

By saving early and often for your retirement, you can take advantage of compound interest and the time value of money. Every month interest accrues on your principal amount (the money you invested or saved). Then, the following month, interest builds on your principal amount PLUS the interest from the prior month. This results in an exponential growth curve over time! 

What this means is that if you start saving for retirement at age 50, you won't have enough time for the interest to create an exponential growth curve of your savings. This all means that the time value of money only helps you when you start saving early in life.

If you are interested in learning about the topic in more depth, please visit our module on Saving and Investing.

Practice

Now that you know the basics of budgeting, think of paying it forward, and discuss how to create a good budgeting plan with your family and friends. 

Congratulations! You can move on to Chapter 3. Pros and cons of borrowing money.  

To review the full module on 10 Principles of Personal Financial Literacy, click here.