Spending and Saving
Many people focus their energies on increasing their income and do not spend nearly as much time and effort on saving money. Most people have more control over their spending than they do over their income.
Saving money now will bring rewards later on. It’s that simple. Saving money often involves sacrificing something you enjoy for a specific period of time so you can have peace of mind and better financial health. Sometimes saving money involves minimal or no sacrifice.
Saving by sacrificing
Start by understanding your spending. Put your expenses on paper. Start with your regular fixed expenses like your rent or mortgage. Let’s look at Joe the plumber’s expenses:
Car payment: $350
School loan: $250
Car insurance: $110
Cell phone: $100
Total fixed expenses: $2,260
Total variable expenses: $1,100
Total monthly expenses: $3,360, or $40,320 per year or $110 per day.
If Joe’s income is 40,000 per year (before taxes) then he is barely breaking even. He is not really able to save any money. At some point in the future Joe will be able to save $350 after paying off his car loan plus $250 after paying off his school loan. Joe can expect all his other expenses to go up with inflation except his mortgage which is fixed for 30 years. Joe’s income will likely go up as well. But, it is not clear whether his income or his expenses will go up more. Another unknown is whether he is likely to be unemployed for a few months or more. So Joe needs to cut back on spending to make sure he is saving for retirement and able to deal with potential unemployment. He needs a budget that will reduce his total expense by two to three hundred dollars per month.
What to do?
Joe’s biggest expense rent is about 42% of his total spending. He could move to a smaller apartment. The money he saves on rent can go towards paying off his car and school loans faster. This means he will be saving on interest as well. As Joe’s debts are reduced his credit rating will improve (see Debt and Credit). This could mean lower home expenses should he decide to buy a house in the near future.
The point of this example is to show how a simple list of expenses can be used to make decisions about spending. This example, also illustrate the virtues of early sacrifices on one’s financial position. Being willing to spend less now means having more later.
I listed the daily total expenses for Joe ($110) because that value is useful in evaluating everyday expenses especially impulse purchases. Joe can use this figure before buying his second latte of the day. He can say, “each latte equals 3% of my daily expenses ($3.30/$110). Perhaps I should stick to one latte per day.”
Savings with little or no sacrifice
1. Avoid fees, penalties, and fines
Be disciplined about paying your bills on time. Know your balance before you charge on your debit card. If you use ATM a great deal then consider opening an account with an online bank (see Banking for details).
2. Choose the right CD
It pays to look closely at the terms of each CD option. In general the longer you are willing to keep your money locked-up the higher the interest rate. Many banks and credit unions charge two months of interest if you take your money out before maturity. Do the math before deciding what to buy. If your bank pays 3% on a 5 year CD and 0.5% on a 6 months CD consider purchasing the 5 year CD even if you will take your money out in 6 months. Two months of interest = 0.5% for the 5 year CD. So 1.5% interest – 0.5% interest = 1%. The six months CD will pay you 0.5% more after 6 months than the 6 month CD.
3. Save on life insurance
First decide if you need life insurance. You need life insurance if your death will cause hardship for someone else. If you think your family will manage fine without additional funds to replace your lost income. Then do not do it. If you decide you need life insurance to protect your family in case you die then buy term life insurance not whole life insurance. The difference is that whole life insurance mixes investing with life insurance and costs too much money. If you are not convinced read this article: Term or Whole?
4. Do not buy your credit report; get it for free here: http://www.annualcreditreport.com
5. Avoid eating out
If you eat at a fast food restaurant often you will likely be harming your health. If you add future health expenses to your fast food budget you will see how expensive this type of food can be. If you eat at upscale restaurants you will likely be paying $20 to $60 for a meal. The internet is full of recipe sites (and YouTube cooking demos) use them. Cook and eat at home. Here is a site for beginners that can show you how this can be done http://www.cheap-and-easy-recipes.com/sitemap.php
Here is a simple Excel template for budgeting and tracking costs.