Saving money is something we should all learn how to do, but it isn't as simple as you would think. People try all kinds of ways to save money, but what's important is to do it regularly and to make budgeting your money a habit. You can't expect to just sock away thousands of dollars overnight. There are several steps you need to take before you can even think about investing in the stock market, retirement plans, or anything else above and beyond what you use for paying bills.
This article has a number of helpful money management tips, and will explain the steps you should take to make sure you are secure enough to invest for other goals beyond basic living expenses as well as trying to increase your cash flow.
The good news is that once you've followed the budget planning strategies suggested in this article, you'll find that saving money can become a habit which is easy to maintain. The best way to save money is to do so methodically and to understand that all the money saving tips in the world can't help you until you decide to make some changes.
This article is very in-depth; it should answer any questions you may have about how to save money. As a former financial advisor, these are all the things I did for clients to help them get started - all of my best tips on saving money are here. There will be some simple math, but I will try my best to keep everything as simple as possible and explain it in detail. A calculator to do simple addition and multiplication would be helpful.
- Budget: First and foremost, you need to have a budget. I know this is something that doesn't seem terribly difficult or important, but many people skip this step entirely. A budget is the basis for anyone who wants to invest. Learning how to allocate your money will help give you a scope of where your money is going and what you may have left to invest later.
Keep in mind that the matter at hand is your gross income -- what you make before you save taxes. Your gross income will be listed on your check before they show the deductions for taxes, medical, insurance, etc. Your net income is what you take home after these expenses. I want you to look at things in this way to develop an idea of where ALL of your money is going. I will provide some tips about how to budget money later, but let's start at the beginning.
- Expenses Worksheet: When conceiving a financial budget you must first know your expenses and what you spend money on regularly for leisure. I have included a relatively simple worksheet that you can use to track your monthly expenses so that you will be able to determine average spending every month.
- This Expense Worksheet is relatively self explanatory and is broken down into weekly increments. If you have never tracked your expenses before, you will want to start with this worksheet. Keep it with you; make sure to update it when you pay a bill, make a purchase, or spend money on a service. You need to do this step to provide yourself with a realistic expense list. I recommend that you add Taxes, all insurance premiums, and any other things that are deducted from your check in the Other section. Those are all expenses that you pay too, but unless you look at your paycheck, you really won't think of them as expenses. We are trying to maximize your total Net Income here, so we need to start at the top.
- For expenses you pay annually, such as insurance premiums, I want you to break them down into a monthly number. Just take the entire amount you pay annually and divide it by 12. Enter that on the right with the totals. You don't need to break it down into weeks. We do this is because we really want to earmark that money for the premiums you have to pay and make sure you are planning for them. This money is not "extra" cash; it will be used for these expenses at some point in the year. For that reason, it should have an impact on how much you spend on a monthly basis. You may not actually have a particular expense every month, but you do need to plan ahead and save money for that purpose.
- You may want to do this for longer than a month to get a better idea of averages.
- Budget Spreadsheet: The next step is to actually create your budget. After compiling all you expense information, you are ready to get rolling on your income. Here we will determine your cash flow. Cash flow is the difference between what you make and what you spend. It may not be the same every month, but if you plan ahead and create a budget, you should be able to determine an average that shows you how much extra you have per month, or how much you are going in the hole every month.
Now that you have your expense numbers you can start entering information into this Budget Worksheet:
- The budget worksheet combines everything from your other worksheet with your income. Notice that it says "Gross Income" at the top. This is what you make before taxes. You might wonder how we can determine your average income per month since there are 28, 30, or 31 days in any given month. As with anything else, we have to do a bit of math. Simple math, though, so don't worry. Here is a formula:
Gross Income per Month = (Weekly Gross Income * 52)/12+(Total bonuses/12)+(Other income/12)
- As the formula states, we take what we make every week and multiply it by 52 (number of weeks in a year). Then we divide that number by 12 (number of months in a year) to come up with what we average per month. If you get bonuses in a year and their amount is known to you, you will also have to divide that by 12 to get an average. If you have any other income during the year, you also will want to total it up and divide it by 12 for that average. Then you add it all together to arrive at your average total monthly earnings. If you only have income from wages and nothing else, just disregard the rest of the formula.
- This formula can be used for what you pay in taxes as well, but isn't typically necessary since you already logged them weekly in your expense worksheet. If you want a genuine total, multiply the weekly taxes by 52 and divide them by 12 to get a true monthly average.
- Those previously mentioned annual expenses should be entered here in their monthly form as well. There are also some other expenses you should consider. Gifts are a great example. What do you spend during holidays or for birthdays? This is a really tough question, because many don't plan ahead for these types of expenses and spend a random amount. Do you spend $1000 a year for Christmas gifts? $2000? More? This should be considered a monthly expense even if it only happens a couple months out of the year. Do as you would with insurance premiums and divide that total by 12 to get an average for the month. No one likes to skimp on giving, so be sure to save ahead for gifts. You also can save by using coupons for your purchases; in fact, this is one of the easiest ways to save money. ChristmasCoupons.com is an excellent website to help you save at the holidays.
Phew...that's a lot of information about expenses and income. We're not quite done with this worksheet yet, however. Now on the worksheet you have all these expense totals and your Gross Income total. Just subtract all the expenses on the sheet at the bottom from the Gross Income at the top to come up with your monthly surplus/shortage. This is called your monthly cash flow as well.
Does it look accurate to you? Is it really far off? If it looks fishy, you will definitely have to go back through and make some adjustments. Sometimes you may overestimate certain expenses, or simply underestimate others.
- Cash flow (positive). So what do we do with that little monthly number at the bottom of our budget? If it is a positive number, we have to verify that you are actually ahead every month. Are you building up cash in a savings account every month? If so, that is a definite start to show you have a positive monthly cash flow. I hope you aren't saving cash by putting expenses on credit cards though. Unless you have 0% interest and are going to have enough to pay that off before the rate jumps, you really aren't in the best position to save quite yet.
It's nice to have some cash sitting in savings, but think about it a bit more realistically. A savings account pays you maybe 2% interest if you are lucky, while a credit card charges you a significant amount more than that. It really isn't in your best interest to string out a credit card balance if you have cash on hand. Some of my past clients have had a few thousand dollars in savings, yet had a credit card balance of a few hundred dollars at 10% interest; they were just paying it off monthly instead of biting the bullet and paying the whole amount. If you are a fan of credit card companies and like to donate extra money to them, that is fine, but I for one don't recommend donating money to for-profit businesses if you can avoid it.
We have some options to help you increase that number if you are negative, or positive. First and foremost I want you to understand your taxes.
- Do you get a HUGE tax refund every year? Is your refund in the thousands? Has the IRS ever given you interest on the tax money they have been lent by you all year? Of course they haven't. So why do you insist on letting them hold your money for free all year?
- I understand this is kind of an arcane way to force yourself to save money but, aside from earning extra money, there is no better way to increase your monthly cash flow than to know what you will pay in taxes for the year. If you get a refund of $1200, you may be shortchanging yourself every month. That's an extra $100 a month you get NOW instead of next year. If your tax refund is larger than that, you have even more per check. Many people allow the government to hold this money for them, but are short every month and are forced to put purchases on credit cards.
- The easiest way to figure this out is to look at your previous year's tax return. If you make relatively the same amount as you did the year before and have the same deductions for the most part for the upcoming year you should have the ability to add something to your monthly cash flow considering you had a large refund the year before. You should be able to estimate how much more you could have a month just by dividing your past refund by 12. By knowing this you can adjust the amount of exemptions you claim on your W9 at work.
**DISCLAIMER** DO NOT MAKE ADJUSTMENTS TO YOUR W9 WITH OUT SPEAKING TO A TAX PROFESSIONAL**
There is really nothing more rewarding for me than to find a way to come up with some budgeting tips that will help increase a client's monthly cash flow. The tax tip is really just a taste of some things you can do to help yourself, but every individual is different. If you got to this point and found you have a steady positive cash flow, are actually putting money into savings on a month to month basis, and have little credit card debt, then you are in a good position to start saving.
If you find yourself with a negative cash flow, you need to start cutting back and living within your means. Adding a bit per month from taxes will help, but your efforts to save might need to extend beyond that. Other options you have to consider are to cut back, make more money, or find yourself some debt counseling. I know how difficult it is to cut back. Self-control needs to be learned and practiced. It's important to sit down and come up with some money saving ideas of your own - ones that are suited to your own lifestyle. Just remember that even if you can't see the benefit of these strategies to save money right away, every little bit helps!
- Cash Reserve: Yes...you need to have some money in your bank accounts before you can start pumping money into the stock market, real estate and mutual funds. Typically for a client, I would recommend that they have at least three months of expenses saved. You need that little nest egg for yourself just in case an unexpected expense or emergency comes up. What if the car breaks down? What if you need a new refrigerator? Where is that money going to come from? Credit? That's what most people think, and that is why many people are in debt all the time. I really don't want you to put yourself in a position where you must use credit cards to pay for things. Credit cards are great for emergencies, when you are out in the middle of nowhere and have no access to cash, but they are a bad habit if you are not able to control yourself with them. I want to take the temptation away as much as possible by having you build a cash reserve.
A cash reserve is like any other investment goal. In fact it is priority #1 for me. It precedes every other investment you will undertake, and building a cash reserve is easy. If you already have a positive cash flow, you probably already have a reserve, unless you just go out and buy something fun when you see you have a bit of money in your account. If you have the positive cash flow, you will want to maintain a three month reserve. Keep saving your excess money until you get there.
Tiered Cash Reserve: You were probably thinking that having three months of expenses sitting in a regular bank account is rather silly. I agree. That is why I advised clients to maintain a three-tiered reserve. Each tier is one month of expenses.
- The first tier is simply your normal bank accounts -- checking and savings accounts. This is above what you put in there for monthly bills and what-not. You still have income, so you typically won't be spending this money every month. You will, however, prevent yourself from over-drafting by having this money in your primary bill paying accounts.
- The second tier is more of a Money Market savings account. A money market account is available at most banks and is used much like regular checking accounts if they allow you to do so. The difference is that the interest paid is much higher than a regular checking account, so you will be able to earn something on this money while keeping it easily accessible. If your money market account allows for bill paying, debit cards, etc., you may want to just disregard the first tier and keep two months of expenses in this account.
- The third tier is still pretty accessible in an emergency, but will have some restrictions placed on it. You are looking for a better rate of return on this money than you are for your other tiers. The only issue is that, to get this kind of return, your money may be locked up for a few months. CDs, Stock Market Certificates, etc. are the kinds of investment you want to consider here. These investments will pay higher interest than a Money Market account, but only if you leave them invested for the entire period (three months, six months, or even 12 months). If an emergency does arise, you can get your money back from these investments fairly easily, but may lose some interest that you made.
Of course, there will be times when it is easier to save money than others. If you're having a lean month, you may find it helpful to keep some money saving techniques in mind; these easy ways to save money will help you stay on track, so you're still able to save money during hard times.
Now that you have learned how to manage your money and have built a suitable cash reserve, you are ready to start with other goals -- retirement, college, vacations, or any other goal you may have. At this point you are really in a position to speak with a professional financial advisor to have them take care of your investments. They spend their days learning all there is to know about investing, whereas you have your own job, kids, and home projects to worry about. The best way to find an advisor is through someone else you trust. All advisors will give you a free consultation, so you can see if they are a right fit for you. If you decide to start investing on your own, please spend a significant amount of time learning about your options and determining what is important. You can take online finance classes to speed up your learning process. It isn't all about the highest return mutual fund all the time; there are many other factors. Spend time learning them, as well as learning how taxes affect your investment.