The Road to Financial Freedom

The other night, I was talking to a friend, W, over the phone... and I was inspired by the amount of savings she manages to accumulate each month.

W receives salary of around $2,300, and is able to put aside $1,200 in her online savings account each month. That is an impressive savings rate of >50%! And since she gives a monthly allowance to her parents of roughly $600, that essentially means she gets by with only $600 each month!

Let's do the sums. Assuming W starts off with a net worth of $20,000. The forced savings of $1,200 will increase her net worth to $34,400 at the end of one year (ignore compounding for now, since interest rates in Singapore continue to be very low). If, a year later, her salary increases by $500 and she is able to put aside $1,500 in forced savings. Two years later, her net worth increases to $52,400. These calculations did not include bonuses, so assuming bonuses of $10,000 for each year - her net worth at the end of two years increases to $72,400!

To make a comparison, assume another friend, K, earns $3,400 a month, and spends $2,800. She justifies the extra spending as she has to be on par with her colleagues in terms of dressing, and dines out frequently with her friends. After taxes, she manages to save $500 a month. A 15% savings rate is a decent amount, especially for fresh college graduates just starting out. Starting with the same net worth of $20,000, she ends up with $26,000 at the end of one year. A year later, her salary increases by $800 and thus she increases her savings to $1,000 a month. At the end of two years, her net worth increases to $38,000. Her bonuses amount to $30,000 over two years, of which she saved $20,000. Her net worth at the end of two years becomes $58,000.

Earnings (Annual)
K $ 70,800
W 47,600 (48.7% less)

Net Worth
End of Year 1
K $ 36,000
W 44,400
End of Year 2
K $58,000
W 72,400

This may be a simplistic example, but it teaches us an important lesson in financial planning - that net worth is determined not by how much you earn, but by how much you spend! K earns on average 50% more than W each month, but her net worth is 25% less than W's! Extrapolating this trend, it's not hard to figure out who ends up richer. Since both of them live in the same city and are subject to similar costs of living, differences in net worth is a result of differences in consumption and saving habits. And it's all the more inspiring because this is a real-life example so you know it can be done!

So, instead of thinking negatively and complaining about how little you earn from your job, change your thoughts to positive ones! You now know that you can use your cents to build up future riches!

Here is a useful formula to follow: Expenses = Income - Savings.
W makes a conscious effort to spend only what is left after saving up a specified portion of her income. K uses Savings = Income - Expenses, and while the formulae are equivalent, she spends first and saves up whatever is left. This typically leads to overspending, because people tend to spend when they see positive balances in their accounts!

Make it a habit to save from today, or else you'll make it a habit to spend! Which would you prefer? :)