How to Save Money and Create Financial Security

This post is the second in our five-part series about taking charge of your finances in 2010. Last week I covered the first pillar of personal finance–setting goals. This week we’ll address a topic that you simply can’t build financial security or wealth without–saving money!

Why Save Money?

You may not have control over many aspects of your life, like the economy, the stock market, or the price of real estate, but you do have control over how you spend your money. If you read last week’s post on goal setting, you know that creating a spending plan is the best way to fund your financial goals. A spending plan is simply a map of your expected cash flow. You list all sources of income and decide how that money will be spent, long before you receive it.

Many people have difficulty sticking to their spending plans because they just can’t get a grip on their everyday spending. Or they may view savings as the enemy of having fun and rebel against it. It’s important to realize that when you save, you’re actually spending money on something incredibly important and powerful–financial security. You’ve probably heard the saying “pay yourself first”. That means you should make saving for your current and future needs a priority over other expenses.

I like buying things as much as everyone else. New shoes make me absolutely giddy, but I also know that they can’t pay my bills during retirement! Veering away from your spending plan usually means you’ll save little or nothing at all. That takes you further away from reaching your goals, rather than moving you closer to achieving them. It takes a lot of maturity to know that you have money to buy something that you want, but to decide that you really don’t need it and would be better off saving the money instead.

The quick and dirty tip for saving is to live below your means with a realistic budget that balances your current and future financial needs.

When Should You Start Saving?

If you’re wondering when you should start saving money, the answer to that question is right now! You’re never too young or too far away from goals, such as retirement, owning a home, buying a car, or paying cash for a vacation to put off saving.

An Example of the Importance of Saving Early

Consider this example: Let’s say you have two friends, Terry and Tim, who are twins. They just graduated from college and are doing similar jobs earning about the same amount of money. Terry is fun-loving and always foots the bill for her friends wherever they go. She hasn’t saved a dime since she started working and has even accumulated some credit card debt. She reasons that she’ll earn much more money in about 10 or 15 years, and she’ll pay off her debt and start saving then. Tim, on the other hand, is very concerned about whether he’ll have enough money to retire as early as he’d like. He doesn’t have a retirement plan at work, so he opened up a traditional IRA and started contributing $100 each month to it.

Now, I want you to time travel with me 35 years into the future to see what’s going on when they’re both 60 years old. Besides having wrinkles, gray hair, and needing reading glasses, what happened to their money? Well, Terry did eventually start saving $250 a month or $3,000 per year. She did that for the past 20 years. Tim, on the other hand, only saved $100 a month or $1,200 per year–but he saved that amount for 37 years. For the sake of simplicity, let’s assume that they both invested their savings into a stock ETF in a traditional IRA with a 7% annual rate of return. So how did it turn out?

How Compound Interest Affects Savings

Terry’s nest egg totals over $130,000 but Tim’s is over $206,000. Terry had to save $60,000 ($3,000 x 20 years) in order for her fund to grow to $130,000. But Tim only had to save $44,000 ($1,200 x 37 years) for the same investment to grow to $206,000. Put another way, Tim saved 26% less than Terry, but now has about 59% more money than she does! It almost seems impossible to save less and end up with more; but it is possible due to the power of compounding interest.

When your interest compounds, it’s sort of like double-dipping because you earn interest on your savings and on the interest you already earned. That makes long-term investments grow dramatically. But the only way to take advantage of compounding is to start saving early. When you do that you’ll get a lot more for less, and who doesn’t want that?

How to Make Saving Automatic

In order to kick start your New Year’s saving resolution, I can’t think of a better way to do it than by making it automatic. Payroll deductions for workplace retirement plans are fantastic. Be sure to always contribute to them, especially when your company matches your contributions. If you’re paid by direct deposit, you could instruct the HR department at work to send a percentage of your pay directly to a savings account. Or you can use online banking to set up a recurring transfer so money is automatically withdrawn from your main payment or checking account and deposited into a money market or IRA, for example. That way you don’t have to think about saving, it’s done consistently, and you probably won’t even miss the money after getting into the groove of your new routine.

Summary

To sum up, the best way to become a better saver is to make it part of your lifestyle. Don’t put yourself in situations where you could be tempted to overspend. If you don’t have money budgeted for buying clothes, for instance, don’t go to the mall on a Saturday with a friend–go to the park or beach instead. A couple of resources for great saving tips are americasaves.org and choosetosave.org.

Lastly, remember that you can also control what happens to money you don’t spend.  Put it in a high interest savings account, and don’t fall victim to bank fees that will eat away at your money.  Find out more about where people usually get hit the most in this episode on money management, and in this Quick Tip about overdraft protection.

Remember that it’s not really about how much money you make, but about how much you vow to keep for yourself. Your financial security is riding on your ability to put off what you could have today, so you’ll have ample financial resources to draw from later on.

Again, this post is the second in our five-part series about taking charge of your finances in 2010. Each article in the series is about a pillar of personal finance—setting goals, saving, investing, being properly insured, and reducing your taxes.  Please click on the links to head over to the other episodes.

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