What's left at the end of the month
How much you save each month has the biggest effect on your result. To know it, you need three numbers: fixed costs, variable costs and a reserve for costs that only come once a year.
Learning objective: After this lesson you can work out your own savings rate from fixed costs, variable costs and annual costs.
Most people underestimate their spending because the big items that only come once a year slip their minds: insurance, holidays, Christmas, the car repair, the tax bill.
Tracking Your Spending
Take your bank statements from the last three months and sort everything into three pots:
- Fixed: rent, electricity, insurance, subscriptions.
- Variable: groceries, fuel, leisure.
- Annual: everything that comes once a year, divided by twelve.
An example: Lena takes home €2,400. Fixed costs take €1,100, variable costs €700 on average. Her annual costs, meaning insurance, holidays and presents, come to €2,400 a year, which is €200 a month. That leaves €400. That's her honest savings rate, even if she'd like it to be €600.
Automating Your Savings
A practical tip: set up your savings as a standing order for the day after payday. What goes out first doesn't get spent. What's supposed to be left at the end of the month almost never is, as experience shows.
The formula for the final value of a savings plan shows how strongly the savings rate works: E = R · ((1 + i)n − 1) / i. Here R is the monthly amount, i the monthly interest rate and n the number of months. Double the amount means double the result, with no uncertainty at all. The rate i, on the other hand, you can't set, only estimate.
Savings Rate Before Return
That leads to an order many beginners turn upside down. Effort you put into a higher savings rate works for certain. Effort you put into finding the best return works maybe. Hunting for the perfect investment first means optimising the uncertain number and leaving the certain one alone.
Planning for Annual Costs
For annual costs, a separate account works well, with a twelfth of the expected yearly total paid in each month. That turns irregular spending into regular spending, and your savings rate stays predictable. Without this step the savings plan gets paused again and again, which interrupts compound interest exactly where it pays off most.
Data as text
The labels show €70,000 at €100 a month, €139,000 at €200 a month, and €209,000 at €300 a month. The bars distinguish contributed from return.
Summary
- Three months of statements say more than any estimate.
- Divide annual costs by twelve, or the numbers never add up.
- Save first, then spend.
Did you get it?
Which number in your savings plan can you influence for certain?
The savings rate. The return you can only estimate.
Why do so many people miscalculate their spending?
Because items that only come once a year, such as insurance, holidays or repairs, are missing from monthly thinking.
Why does a standing order right after payday help?
Because what's in the account gets spent. What goes out first isn't there to spend.
Check your understanding
Your task
Sort your spending from the last three months into fixed, variable, and yearly costs, and divide the yearly costs by twelve. Subtract everything from your take home pay and write down your honest savings rate. Enter it in the savings plan calculator against a rate that is $50 higher, and note how big the difference is after 20 years.
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- Before you invest a single euroStage 0
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