Personal Savings: How to Start

If you are like most people (most of you are), you find it hard to put money away in savings with any regularity, and even if you do put money away, you have trouble keeping it there and building it to any sizeable amount. Today, we will explore ways of building your savings and protecting yourself from yourself.

When we speak of savings, we must keep in mind all of the reasons that we save money. We might put money aside for emergencies, or we might be saving for a major purchase (i.e. car, boat, house), or perhaps for major needs such as college for the kids or our own retirements. In todays issue, we will speak mostly to saving money for emergencies and major purchases. College and retirement savings encompass many methods, uses, and tax consequences, so these will be dealt with individually in future articles.

Emergency fund savings seems to be the hardest for people to latch onto, because it is so hard to define a true emergency versus an inconvenience. In addition, if you carry debt, it can be all too tempting to just pay down credit cards, and use the credit cards when an emergency happens. I know. I've been there. However, a cash emergency fund is the way to go. If you have a credit card spending problem, raiding your savings account is not the way to fix it. We'll deal with credit card misuse and traps in a future article as well.

PAY YOURSELF FIRST!

The first rule in establishing personal savings is to PAY YOURSELF FIRST! I know, I know. You have been trying to pay all of your bills, and you are afraid that if you pay yourself first, you won't have enough money for the bills. Trust me. You can make this work, but ONLY if you pay yourself first. The government may not do a lot of things well, but even they know that if you pay them first, your taxes will get paid. Follow their lead here.

Your payroll check includes deductions for Income taxes (state and federal), FICA/MEDC for retirement (as if!) and future medical care, SDI (State Disability Insurance), and may also include withdrawals/contributions to retirement plans, 401(k), and other withdrawals that you have authorized. I will ask you to either authorize a 5% to 10% automatic deposit to your savings account by your employer, or implore you to make this deposit to savings yourself, when you deposit your check each pay period. Once you make this deposit, forget about touching that money.

Now, if you are used to living paycheck-to-paycheck, this may be difficult at first. You may find yourself running short on money near the end of your pay period. This may mean going to a couple less meals out or see fewer movies, or perhaps making some dietary adjustments. This is a good thing. You need to reign in your expenses, and a pay reduction is good medicine for that.

Where I find great success in this is when a client receives a promotion or changes jobs into a higher salary. If this happens to you, take at least one-half of the increase, and add it to what you are saving. If possible, take all of the increase. If you are just starting out, graduating college, or getting a first job, it may be easier to put money away, because you aren't used to having much anyway.

Your emergency fund should build to six months' expenses over time. (Some planners recommend six months' income, but I find that this sets the bar too high for most people.) This assumes that you are able to maximize your contributions and not touch the money. This can be hard when life throws you a curve ball, but if you can increase your emergency fund by one month's expenses every year, you will improve your financial security over time.

TAX WITHHOLDING AND REFUNDS

If you are receiving a large tax refund every year, I recommend that you submit a new W-4 to your employer that will eliminate this refund. This will result in a bigger paycheck, and I recommend that you take this increase, and add it to the 5% to 10% that you are already saving. It amazes me that people will struggle all year with credit card debt, and then use their tax refund to pay off the credit card. The IRS paid you 0% interest on that money, while you paid your bank up to 20% or more! Save the interest, and just take the money when you earn it.

Now that you have a savings account for emergencies, let's talk about major purchases. Since we live in an era of (usually) easy credit, many fall into the temptation to purchase expensive items that they cannot afford. I know that you would never do this, but I have a theory on how best to prove to yourself (risk-free) that you can afford something, while saving you a lot of money in the meantime.

BUYING YOUR FIRST HOME

If you want to buy a house, I make this recommendation (especially if it is your first house): Don't buy it yet. This is my recommendation in most markets, but in the present housing market, you have two years before things are really going to get back to normal, as short sales and foreclosures are going to depress markets for at least that long. Banks are starting to recover from the sub-prime fallout, but I think that more writedowns and closures are still possible.

What I would recommend instead is to find a house that you would really like to buy, and that you think you can afford. Take the sales price into account, and see a mortgage broker to find out what kind of terms you could get for a loan in your current situation (income, credit score, and other factors). Calculate taxes and insurance based on the listed price. Once you compute the total house payment (PITI), get an estimate for the upkeep costs on the property. Figure 10% of your monthly loan payment for maintenance, find out the cost to do yard maintenance if you would hire that done, and get an estimate for the utilities (gas, elec, water, trash, pest control). Add all of these numbers together. This becomes 'X'.

Take 'X' and subtract from that number the amounts you now pay for rent and utilities each month. This new number is 'Y'. For the next two years, I want you to deposit 'Y' into a separate savings account on the 1st of each month. If things happen, and you can't pay on time, and you happen to pay yourself after the 15th of the month, I want you to add 5% of 'X' to your savings deposit. If you can maintain this payment for two years, you have proven that you can afford the house, and you should have a sizeable kitty to use for a down payment, closing costs, and reserves. You may also find that you now qualify for a better interest rate, because your financial situation has improved over time.

CAR PURCHASE STRATEGY

If you want to purchase a car, I recommend a similar approach. Find out the cost to purchase the car you would like to have, determine the payments, insurance, registration, and maintenance costs of that car. Then, take the money that you would use for a down payment, and purchase a passable, but dependable, car for that cash. Each month, pay into a separate savings account the amount of costs that you would have had, if you had purchased the car you had in mind.

If the car you bought requires any excessive maintenance (repairs over $200), you may take the money from the savings account for those repairs. If you get an exceptionally large estimate, you can use the accumulated savings to buy a new car. If you only put $400 per month into the account, you will have almost $5,000 by the end of the first year. If your POS (lousy) car lasts two years, you should have about $10,000 available, less any repair costs withdrawn.

When the car dies, spend up to the total amount of cash you have saved on a replacement vehicle. Be sure to update the amounts you are saving to take into account the inflated costs at this point, and continue to place this new amount into your savings account each month. If you do this properly, in a few years, you will be able to afford almost any car you want for cash. Keep up this habit, and you will save yourself tens of thousands of dollars in interest payments over your lifetime.

If you want to purchase a boat or jet skis or any other non-essential item, do the same thing as with a car, but spend two years saving money towards the purchase. You might change your mind about buying the item, in which case you can apply the money to any other purpose, or you may be able to pay cash or a significant down payment when you are ready to buy.

These are just a few ways that you can save money. Build your emergency fund, plan ahead for a house, pay cash for your cars, and delay your gratification for other major purchases, and you will keep yourself from biting off more than you can chew financially. You may also find that this sort of discipline pays a benefit to you in that you will be less likely to act on a whim that can spell financial disaster for you and your family. If something really bad happened, but you were saving money for a car or house, you will be grateful that you had the extra cash on hand. Having extra money can also enable you to take advantage of opportunities as well.

I welcome your comments, suggestions, and stories. Blog to you soon!