How do I start taking charge of my savings?

A student asked me this question:

How do I start taking charge of my savings? Financial literacy looks so daunting that I have no idea where to begin!

first of all, we need to be clear about why we’re saving money. Saving money just for the sake of having more money lacks strategy, purpose, and direction on what the money should be used for.

So here are a couple of savings objectives that you should plan for:

(1) Rainy day fund. This should be the first goal to work towards. You need to save at least 6x your monthly expenses. So if you spend $2000 a month, your goal is to have $12,000 in your bank in case of a financially difficult situation. This fund is meant to cover you in the event you get unemployed. Most people take up to 6 months to get a new job after losing their jobs, hence the multiplier of six.

The older you get, the more responsibilities and commitments you’ll have. And this may mean that your monthly expenses may increase. For example, as a student, your monthly expenses now may just be $400 a month. As a young working adult with bills to pay, maybe $800 a month. As a parent with two mouths to feed, maybe $2500 a month. So you’ll need to adjust this rainy day fund as your life situation changes.

(2) Sinking fund. A portion of your savings should be set aside each month to pay for the future replacement of essential expensive items, like laptop or smartphones. This way, you won’t feel like it’s a huge heart pain when the time comes for you to buy a replacement. When you don’t plan for these kinds of things, it will be psychologically very difficult to make some of these purchases in the future, or you’ll make compromises just to save every dollar possible to make it happen. That’s irrational behaviour due to a lack of foresight. The reality is that there are expensive things that we have to pay to replace every now and then. So it’s important to set money aside for that eventuality.

How do you decide how much to set aside for your sinking fund? Let me use the example of my Macbook Pro. I bought my Macbook with the intention of replacing it in 5 years time. A Macbook costs about $2200. So basically, I’ll set aside $2200 / (5 x 12) = $36.67 a month for the next five years to save for a new replacement.

In the future, your sinking fund should include things like expensive home appliances (refrigerators, or even home renovation in 10 years). Let’s say I buy a $1000 refrigerator with the intention of replacing it in 10 years time. So I’ll need to say aside $1000 / (10 x 12) = $8.33 a month to save up for a new replacement refrigerator.

The same concept can also be applied to periodic expenses like a holiday. If you want to play a holiday 2 years from now, then you’ll do a budget estimate and divide that by 2 x 12 = 24 months, so you know how much to set aside.

(3) Saving for Milestone Events like Wedding, Housing, and your first Home Renovation. This can be the most daunting for many, because these things aren’t cheap!

For reference, my wedding cost $45,000. Housing deposit is 10-20% of the total price of the flat depending on the loan you take. In my case, the deposit we paid was around $45,000. My home renovation cost another $45,000.

Of course, this can seem very scary and daunting. But the reality is if you work a few years, you would have accumulated enough money in your savings and CPF. In my case, we acquired enough money in our CPF to pay for the housing deposit.

With weddings, you can defray some of the total expenditure with ang bao collection. But DO NOT put blind faith in the hopes that you’ll get enough ang bao to defray 100%. People like to say things like that, but it doesn’t always happen.

Anyway, after you’ve accomplished saving up to build your rainy day fund, you can start saving towards paying for these expensive milestone events.

(4) Retirement fund. Woah… I know that many of you haven’t even started working. So the idea of planning for retirement sounds crazy. It’s so far away, it’s hard to even imagine it. But it’s important to plan for retirement as early as possible because you really need the time to accumulate all that wealth.

The basic idea behind retirement planning is to save enough money that you can support yourself until you die.

Suppose the retirement age is 67, and most people die at 90. Let’s imagine that to live a comfortable life, your expenses is $2000 a month. So you’ll need to save enough money to support your expenses for the next 23 years of your retired existence. That comes up to $2000 x (23 x 12) = $552,000.

Note that I’m keeping things simple for the sake of explanation by not factoring in rising cost of living, inflation, etc. Once you factor all those things in, it’ll be much much more than $550k.

Of course, the reality is, with the advancements of science and technology, we are expecting people to live even longer than 90 years old. Maybe 100 or even longer than that. And if you live longer than what you’ve saved, you’re in for trouble, because you will not be able to support yourself.

Now, mandatory savings like CPF will help fund your retirement, but going with the default option won’t be enough.

So the ideal situation is to accumulate enough wealth that the money does the work of generating more money for you. As a general rule of thumb, you should aim to save AT LEAST 25 years worth of your monthly expenses. Why?

For example, if you spend $2000 a month, you’ll need to save $2000 x (25 x 12) = $600,000.

There are many low to medium-low risk investment products out there that can generate a sizeable interest rate of 4%. It’s not much but you can be assured your money doesn’t disappear without a warning.

At a 4% interest rate, $600,000 will generate an interest of $24,000! And if you divide that up by 12 months, you’ll get $2000 a month to support your day-to-day living. You don’t even need to touch the principal sum of $600,000. It’ll continue to sit there and produce $24,000 for you each year.

Now, I say at least 25 years’ worth of your monthly expenses. If you can aim higher, you should. Why? Because these numbers do not factor for things like inflation and increased cost of living. So $2000 now might support your lifestyle quite comfortably, but it may not be enough to support a comfortable life when you retire.

Of course, right now, you must be thinking, how the hell am I supposed to make so much money?

So this is where we come to issues of budgeting and financial planning.

(A) The first rule of thumb is that you ought to save AT LEAST 20% of your salary. Let’s say your salary is a somewhat modest $3000 a month. 20% of $3000 is $600. If we go with the $600,000 retirement goal (remember: the $600k is not a magic number, it’s just an example I used earlier), and assuming your salary stays the same, you’ll need 60 years to accumulate this much money if you just go with a savings plan that gives you a 1% compounding interest.

Of course, the hope is that your salary will keep increasing year after year, in which case you can acquire $600,000 before retirement. But the harsh reality is that if you get retrenched in your mid/late 40s and 50s, it’s hard to find a job that will pay you as much.

So don’t leave it to wishful thinking. We need to do better than just save 20% of our salary each month. If you can, you should aim to save even more than that.

(B) The next rule is to treat all savings as an expenditure in your budget. So you are “paying” yourself for those future things, in a certain sense. This is important more for your psychology. We treat money set aside for savings very differently from money leftover in the balance. If you go with a save-the-remaining-balance mentality, it becomes a lot easier to lie to yourself that you can make up for the past month’s over-expenditure. From my own personal failings, I can tell you it rarely happens. So don’t lie to yourself. Many of us lack financial discipline to manage our spending. So, set the money aside so that you won’t touch it.

(C) If you don’t already have a monthly budget, the next rule is to create a budget so that you can have a sense of how much you need to reduce your expenditure, and how far away you are from those savings goals I talked about earlier.

So let’s use the modest salary of $3000 a month for a typical fresh graduate who just entered the workforce. 20% of your monthly salary gets automatically channelled into CPF, so you’re effectively left with $2400 to use each month.

So let’s start budgeting the remainder:

– $600 – is the minimum 20% of your salary that you should save. This goes towards building your rainy day fund; and then your milestone events like wedding, housing, renovations; and finally towards your retirement.

– $100 – sinking fund to pay for a replacement laptop (replace in 5 years) and smartphone (replace in 2 years)

– $40 – handphone bill

– $660 – food and transportation

– $300 – filial piety levy, i.e. money you give to your parents

– $500 – pay off university education loan

– $200 – insurance

Total: $2400

What do you notice? There isn’t much room to spare to do more. If you are the lucky few whose parents are paying your education fee, or if your parents don’t require you don’t give them an allowance, then you’ll have slightly more wiggle room to spend or save.

But don’t forget that your financial commitments will increase once you get married and have kids. You’ll have more expenses to add to your budget. And usually the first thing to go will be your savings.

If you feel worried that you can’t make enough money for the future, good. But no reason to panic or despair.

In my case, I’ve worked for 7 years. And I actually earned $3000 a month for the first couple of years. I was able to save enough to pay off my university education loan, pay all my bills, and pay for my wedding, housing, and home renovations, and still go for holidays overseas from time to time.

So it’s not impossible. It just means spending within your means. You’ve probably seen young working adults living lavish lifestyles on Instagram. If you do the math on how much they’re spending – regardless of whether they’re earning $4000 or $5000 – you’d realise that they’re still spending beyond their means. Based on my estimates, some of them are not even saving the minimum 20%!

The point I’m making here is: don’t envy their lives. They are going down the path of financial ruin in the future. You can live comfortably and happily even if you spend within your means. And you’ll probably be happier off in the future compared to them.

(D) Now, if you do the math, you’ll realise that there’s really no way to hit the retirement target, especially if you’re busy spending the first 10 years of your life building your rainy day fund, or saving for wedding, housing, and renovations.

Getting a higher paid job is not the magical solution. It will help you, yes. But be aware that many companies with very high starting salaries have very low salary increments over the years. So you may not be earning as much as other jobs with lower starting salaries. Also, the more highly paid you get, the more likely you are to get retrenched, especially when you hit your 40s and 50s. High rewards (pay) often come with high risks. That’s just how it is. I’m putting it out here so that you are aware of the risks.

So what then can you do? Saving money alone can’t get you anywhere near the targets. You can try to reduce your expenses. You’ll be suprised how much more you can save if you choose to spend less on food and shopping.

BUT, there’s only so much you can reduce. And if you reduce too much, then you might feel very miserable. No point making yourself very miserable for decades just so you can retire with a substantial amount of money. It doesn’t quite make sense to live like that.

So you’ll need to explore additional sources of income. For starters, a side hustle that will help you make some money on the side is one option to explore. But it can be very time consuming and exhausting. It’s worth exploring activities that don’t consume too much time that can help to generate some additional income insofar as it doesn’t conflict with your main job.

A better option would be to explore ways of generating passive income, things like investments. As you know, banks pay a very pathetic interest that does not grow your money to beat inflation. So you’re effectively losing money by putting it in the bank. So you want to find other investment products like bonds, ETFs, shares, etc., that can help grow your money. Money generates more money. More money generates even more money. So the earlier you start, the more capital you’ll acquire to help you work towards your retirement.

Ok, I hope this was eye-opening. I do hope that you’ll start planning your finances wisely.