Skills you will gain: Understanding how to work out how much you actually save every month
Prerequisite: None, it’s quite easy
Length: 15min
Personal finance uses:
Here's a question for you: if, by the end of the month, you transfer £250 to your savings account, have you actually saved £250?
If you answered yes, keep reading - this lesson is for you. Spoiler alert: the correct answer is no.
Simple Example
Let’s say Bob has £500 in his current account and £1,000 in his savings account (for a total of £1,500). He then decides to transfer £250 from his current account to his savings account.
We can illustrate Bob’s bank accounts in the bar chart below.
Is he £250 richer? Obviously not, as the graph shows that moving money across accounts is a zero-sum game (with the bars representing Bob’s total wealth are the same height).
Bob did not actually save any money, as he is left with £250 in his current account and £1,250 in his savings account, meaning that his net worth remains at £1,500.
From now on, think of monthly wealth creation instead of monthly saving. This will make it easier to understand the logic behind calculating how your total wealth changes over time.
Realistic Example
Scenario: Bob starts the month with £400 in the bank. He earns £3,000 and spends £2,900. Therefore, he now has £500 in his current account, so he transfers £300 to his savings account.
Income: +3000