Financial independence step by step. How to start saving effectively?

Check the numbers and avoid the trap of living beyond your means

Whatever your goal, the key to keeping more of your income is knowing your finances: how much you earn, how much you spend, and how much you actually save. It's hard to improve your savings rate if you don't know how much money is leaving your account each month.

To start, it's a good idea to review your credit card statements and track where your money is going. Make sure you spend less than you earn. Then calculate your savings rate. Which categories are costing you more than you expected? Where can you sensibly cut back on expenses?

If you start earning more, don't automatically increase your spending

For New York couple Alex Nathanson and Josette Chang, avoiding the trap of living beyond their means was crucial on their path to financial independence. They decided not to change their apartment to a larger one, even though they could afford it.

“A larger apartment would just be a whirlwind of whims,” says Nathanson. — Now you want a bigger place, and in a few years you will want something more again. We deliberately decided to get off this merry-go-round.

Treat savings as profit in your company

Steve Antonioni, who has built up a financial cushion for short professional breaks, recommends treating personal finances like running a business.

— An appropriate approach to saving is really very important, he says, adding that the word “saving” itself is confusing from the very beginning.

People use different terms when talking about business and personal finances. Companies have “income” and “profit”, and individuals have “income” and “savings”. Antonioni believes that it is worth comparing these concepts right away.

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— A company exists to make a profit, right? It's exactly the same in your case – your savings are your profit, he emphasizes. — You should manage your life in such a way as to generate profit, because this profit is yours.

One way to increase your personal “profit” is to automate saving before you spend the money. This could mean making permanent transfers to a savings or brokerage account, increasing retirement contributions after a raise, or separating money for current expenses from that for long-term savings.

Try a “no-spend month”

Michela Allocca, who left her corporate job to create personal finance content full-time, prefers to set “spending limits” rather than strict prohibitions.

Sometimes these boundaries are about behavior rather than specific categories. For example, he avoids making purchases over the phone and does not keep his credit card near the computer.

“This creates a certain barrier in the purchasing process,” he says. If he really wants something, he needs to get up, reach for the card and make a more informed decision.

Another strategy he uses is a “no-spend month,” during which he clearly states what he can and cannot spend money on. During one of these months, she decided not to buy clothes or cosmetics.

— But I allow myself to go out for dinner once a week and spend money on my hobbies, he adds. Clearly defined rules for a specific period of time make it easier to stick to your spending resolutions.

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Cuts in the “big three”

To significantly increase your savings rate, it's worth looking at the three largest spending categories: housing, transport and food. These “big three” are usually the largest burdens in the household budget.

“If you learn to control your expenses, you'll free up a lot of money and not have to worry about the little things,” says Josh Lupo, who retired in his 30s with his wife, Ali.

The couple used the so-called strategy “house hacking” to reduce housing costs. Other ways to cut down on the big three include car sharing, using public transport, cooking at home and living with roommates.

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Focus on increasing your income

Cutting down on expenses helps widen the gap between income and expenses, but especially with the high cost of living, increasing your income is just as important.

Recalling the financial decisions she made in her 20s that allowed her to become a millionaire by the age of 30, Allocca emphasizes that increasing her income was key. After all, you can always limit your spending to a certain extent, and earning more opens up new opportunities.

– I managed to achieve these impressive numbers because I increased my earnings outside the corporation – she emphasizes. — This may not be the most exciting solution – not everyone wants to work extra hours or start a company – but this is the greatest leverage.

However, higher earnings only help if you do not also increase your standard of living.

— No matter how much you increase your income, you must avoid the trap of living beyond your means, Allocca concludes. — Otherwise you won't move.

The above text is a translation from American edition of Business Insider