A personal finance guru tells Laura Casado* the three smartest ways to cut costs and grow your savings during the pandemic.
How can you save money during a global pandemic?
Individuals and businesses alike have found themselves coming up against this issue.
To learn some of the best strategies, Business Insider spoke with personal finance advisor and entrepreneur Ramit Sethi, creator of the platforms Earnable and I Will Teach You To Be Rich.
Under what Sethi calls the “CEO strategy” — cut costs, earn more, and optimise spending — he advises people to first focus their energy on cutting costs.
“We often feel guilt because we know we should have done it [cut costs] a long time ago, and we feel overwhelmed because there are hundreds of things we could cut back on,” said Sethi.
Focus on your top three expenses
For most people, Sethi says it’s wisest to re-evaluate your top three expenses that you have the ability to cut back on.
This will often be rent, which you can try to negotiate down, eating out, and sporadic spending on clothing and material items that you may want, but don’t truly need.
“There’s no need to go rummaging around to save on $3 expenses, because you can get the bulk of your cost-cutting wins from those three big items,” Sethi shared.
During the pandemic, it’s especially easy to cut down one a big-ticket item: eating out.
“What’s amazing is that it almost seems effortless at this moment to save money on it,” Sethi said.
“That tells us that cutting back is not so much about willpower, as it is about setting up the right systems long term.”
Use the ‘85 per cent solution’
Sethi shared what he calls the “85 per cent solution”.
If you’re targeting an area of your finances that you want to improve, it’s better to get 85 per cent of the way there and move on, instead of only being satisfied if you achieve 100 per cent success, which can be disheartening and undermine those accomplishments.
“Somebody wrote to me once and told me, ‘Every week, I tell myself I’m going to go for a run three times a week, and I never do it.’”
“I wrote back to her and said, ‘Why don’t you just go for a run once a week?’”
“She writes back: ‘Once a week — what would that accomplish?’”
“In other words, she’d rather dream about running three times a week than actually run once a week,” Sethi said.
He explains that the same mentality can negatively affect attempts to gain control of your finances.
Money is emotional
“Money is about so much more than maths,” Sethi explained, adding that finances can have a big impact on your emotions and sense of meaning.
“Start off with quick wins, wins that you can achieve,” he said.
“You also want to pick something that over time is going to be meaningful.”
“We have this almost puritanical belief that if we just try harder to save, it will work.”
“But of course that hasn’t worked for the last 50 years.”
“Right now, we see that sometimes putting yourself in a situation where you’re almost forced to save money can be really powerful.”
How to calculate your one-year emergency fund
“Many people overestimate how much they need for a one-year emergency fund,” Sethi said.
“They will often say, ‘I make $60,000, that means I need $60,000 in an emergency fund — that’s going to take me forever.’”
“But that’s not true.”
To determine how much your emergency fund should be, calculate the minimum expenses you need to survive, which means cutting out anything that would be more than vital spending to have a roof over your head, basic necessities, and food.
This may still be a substantial number, but it will be more approachable than thinking you need to save an entire year’s salary.
This fund will take time to build, which Sethi says is perfectly normal: “Once you start to see that number grow, you’re going to feel much safer and much better equipped for whatever comes your way.”
“We’re in the riskiest economy in our lifetimes, that’s why playing defence first is really important.”
Automation is key to staying on track
Sethi said that too many people distract themselves trying to determine which high-yield savings account is the best one, when, realistically, small differences in interest rates do not make a meaningful difference.
“The yields on these savings accounts are not that high anymore — that’s fine, that’s normal,” Sethi explained.
“You do not really make money from having your money in a savings account.”
“A common mistake that people make with their emergency fund is spending a month researching the right account.”
“Don’t worry if it’s a 1.3 per cent or 1.4 per cent interest rate — if you run the maths, you’re talking about $2 to $3 a month, maybe.”
“Just find a simple high-yield savings account … and go with it.”
What does make a huge difference, however, is setting up automatic withdrawals of money from your paycheque into the savings account.
“Automation is one of the best decisions you can make in your entire life, ever, bar none,” Sethi said.
He explained that if you don’t automate your savings, you’re depending on “the better angels” of your own nature to remember to manually contribute every month.
And despite all good intentions, most people will forget to do this.
“The data shows us that when you automate contributions to a retirement account or savings account, that money grows because we forget about it and let the system take over,” said Sethi.
“A big finding in personal finance that more people should listen to: Systems over willpower.”
“That is profoundly important.”
* Laura Casado is an Editorial Fellow, Strategy, at Business Insider.
This article first appeared at www.businessinsider.com.au.