Wealth is not about how much you make, it’s how much you saved.
Most people have a pretty good idea of their income every week/fortnight/month. However, in personal finance, the important number is not the amount you made but how much you managed to save. This figure is calculated by your income minus your expenses. It sounds easy, but you will be surprised as lots of people have no idea what their expenses are. Hence they don’t know how much they saved. They may be doing alright, or they may over spend every month. Without working out those numbers, you simply don’t know.
To work out how much you save, you will need to make a profit and loss statement on your finances, just like the financial report for the company. Yes, it may seem time-consuming and lots of hard work, especially for those people who are not good with numbers. So for those lazy Kiwis out there, here is a quick way to roughly work out your saving amount, expense and saving rate in about five minutes.
What Numbers Will You Need?
To do this lazy version of profit and loss statement, you will need three sets of numbers.
Bank Balance this month: Go and gather the balance of ALL bank account, including cheque, saving, serious saver, term deposit and credit card. You can get this number from internet banking or bank statement. For example, today is 28/7, so I need to find out the account balance of 1/7. Make sure you record the credit card balance as negative. Add them all up to get your current cash balance.
Bank Balance 12 months ago: We need another set of account balance (cheque, saving, serious saver, term deposit, and credit card) to compare the numbers. Try to get the balance from 12 months ago, so we cover the income and spending for a full year. You can get that from internet banking (search the balance history) and old bank statement. Add them all up to get your cash balance 12 months ago.
Check out the example above. In July 2016, we have a $2000 term deposit, and it matured during the year. So in July 2017, the term deposit is $0. On the other hand, we opened up a new serious saver account during the year, so in July 2017 we have a second serious saver account with $2800.
Your income after tax and KiwiSaver: We will need to get the income for your last 12 months.
- If you are employed, you can get your gross pay on your pay slip.Also, you can log on to MyIR at IRD to check your gross pay.
- If your income hasn’t changed much during the year, you can use one income to estimate a full year income. You just need to multiply your weekly pay by 52, fortnightly pay by 26 and monthly pay by 12.
- If you know your annual income before tax, put that number into paye.net.nz, and they will calculate your take home pay.
- If you have another source of income outside employment, you will need to add those in as well. (Like Investment income, rental property income)
- If you have uneven income or self-employed, you will need to sit down and review your bank transaction to work out your income.
If you can’t get the bank balance 12 months ago, you will need to adjust your income for the same period. For example, you can only get the balance 6 months ago, then you will need to calculate your income during this 6 months period.
We can work out your saving amount with those two bank balances. Let’s look at our previous example.
In July 2016, the total balance was $17,220 and in July 2017 was $20,596. During the year, the balance increased 20596 – 17220 = $3376. So our annual saving amount is $3,376, average is 3376/12 = $281.33/month.
To work out the expenses, you will need the annual income amount with those two bank balances. The logic behind the math is very simple. You started with your Bank balance 12 months ago: During that year, you made some money, you spent some money and you ended up with the current bank balance.
To turn that statement into a formula will be :
Bank Balance 12 months ago + Income (after tax) – Expense = Currently Bank Balance
We move around that formula, we will get:
Expenses = Bank Balance 12 months ago + Income – Currently Bank Balance
Using our example with a 55K income ($43,065.5 after tax and KiwiSaver). The expense will be
17200 + 43065.5 – 20596 = $39,669.5/Year, $3,305.79/month
Saving rate is the percentage of income you managed to save after expenses. The math is:
Saving Amount / Income Amount = Saving Rate
Using our example with a 55K income ($43,065.5 after tax and KiwiSaver). The saving rate will be
$3376 / 43065.5 = 7.84%
Why do it over a 12 months period?
The main reason we try to get the bank balance and income for a 12 months period is that our spendings are uneven through out the year. Most people will spend more toward the end of the year because of Christmas and new year. If you only cover 6 months from March to September, you may under estimate your spending. If you cover November to May, you may over estimate. So it best to cover a full year.
What If you buy or sell something big during the year?
For example, if you purchase a Car during the year for $10,000 and you are not the kind of people buy car every year, you should exclude that in your bank balance.
On the other hand, If you sold your car for $10,000 during the year and you are not doing that every year, exclude that as well.
Basically, we are trying to work out the saving from your typical day to day income and expenses while ignoring one-time big event.
Should you exclude investment contribution?
Some people may use their savings to do some investing like KiwiSaver contribution, Index fund investing, top-up mortgage payment on rental property or pay extra on your own mortgage. If we calculate the saving with our previous formula, we will treat those transactions as expenses.
Bank Balance 12 months ago + Income (after tax) – Expense – Investment Contribution = Currently Bank Balance,
We turn it around
Expense + Investment Contribution = Bank Balance 12 months ago + Income – Currently Bank Balance
You can see investment contribution inflated the expenses amount. In my opinion, the reason we calculate the saving amount and saving rate is to work out how much money we could invest for our future. Therefore, I will include some investment contribution into all calculation.
I will categorize those investment contributions into two group, Voluntary and Involuntary. Voluntary investment is those you can stop contribution anytime if you choose, like your Superlife/SmartShares contribution, KiwiSaver top-up or you made a lump sum repayment on your home mortgage. Involuntary investment is the one you are obligated to pay, like mortgage top up on your negative cash flow rental property. You have to top up those mortgage payment every month. Otherwise, the mortgage will be in arrears.
Here is an example, during the year, you have the following amount went to investment.
SmartShares Conrtibution – $1,200
P2P Lending – $500
KiwiSaver Top up – $1,043
Own home mortgage voluntary repayment – $500
Rental home mortgage top-up – $3,500
Here is the Saving amount after invesment exclusion on voluntary invesment.
The adjusted saving amount will be 23839 – 17220 = $6,619/year, $551.58/month
Adjusted Saving rate will be 6619 / 43065.5 = 15.37%
The adjusted expenses will be 17200 + 43065.5 – 20596 – 3243 = $36,426.5/Year, $3,035.54/month
What’s the Limitation with this method
This lazy method will give you a rough idea on much you saved, but it comes with limitation and flaws.
- Rough figures: The bank balance will be accurate, but your income amount may not be. It depends on how you collect and calculate your income amount. If there is any error in income, the expenses amount will be off.
- No expenses break down: You will have a rough figure on your expense, but there is no break down on where you spent the money. You simply don’t know where you spent your money without a line by line breakdown.
- Ignore interest income: This method ignores interest you made on your deposit. If you have $20K in the bank with 2.5% interest, it will generate about $330 after tax interest. It is not that much compared to average income, but if you have $200K in the bank, that will be $3300.
- Ignore seasonal fluctuation: This method worked out the income and expenses throughout the year and divided by 12 to get the monthly average. However, in reality, our spending fluctuate every month. In winter, we will spend more on power and gas, we shop more during Christmas and new year and, we may travel during the summer. All those factors will affect your month-to-month expenses and saving amount. You may overspend in some months while saving a lot in others.
Without knowing your saving amount is like driving down a country road at night with headlights off, you may be driving into a hole without knowing. Hopes this straightforward and lazy method will provide a rough idea of your saving amount and shed some light on your financial situation.
If you want to get into the details of your finances, you will have to spend time and do a detail report. We will get into that in the future.