For the first time my husband and I will soon be in a financial position to begin putting away some money and still meet our monthly bills. We'd like to come up with some sort of savings plan. Any suggestions?—M.J.
The most important word in your question — and the one that will ultimately determine how much money you and your husband will be able to squirrel away — is "plan."
For far too many people savings is a haphazard affair of stashing away some money whenever they have a few bucks left over after paying their bills. The problem with this approach is that our needs (or what we think of as needs) have a funny habit of expanding to meet or exceed our income, which means that too often little or no savings gets done.
So to get off on the right start with your new savings program I recommend that you turn the usual savings paradigm on its head. Instead of spending first and then saving what, if anything, is left over, do the opposite. Save first, and then force yourself to live off the rest.
Ultimately, saving is nothing more than living below your means. But doing that is tough. We're hard-wired for immediate gratification. The urge to spend is great, which is one reason so many people, even those with generous incomes, spend all they earn and more. By flipping the typical savings approach, you are essentially forcing yourself to live below your means, or adopt a lifestyle that allows you to save.
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The most effective way to pull off this new approach is to set a savings target and then make meeting that target your top priority. In effect, savings becomes the "bill" that you pay first each month no matter what. People can argue about what that savings target should be. But I'd recommend setting it at least 10% of your salary before taxes and, if you can manage it, 15% of pay, as cited in a Boston College Center For Retirement Research paper.
So, for example, if you're currently earning $60,000 a year, you could set a savings target of at least 10% of salary, or $6,000 a year or $500 a month. By resolving to save that amount each year, you would in effect be committing yourself to live a lifestyle as if you were earning $54,000 annually instead of $60,000.
How you choose to divvy up your income after saving between housing, transportation, clothing, entertainment, eating out, etc. is up to you. If you prefer to live in modest digs and drive a fancy car, that's fine. Or if you'd rather spend more for a nicer home and economize on your ride, that's fine too. What's important is that you stay within the income you have available to you after you've set aside money for saving.
Of course, saying you'll save 10%, 15% or any amount of money is one thing, and actually doing it is another. So the next part of your plan is to find a way to improve the odds that you'll actually save the money you intend to save. And the simplest way to do that is to make your savings automatic — that is, set up a system so that the percentage of your income you earmark for saving goes directly into a savings or investment account before you have a chance to get your hands on it.
So, for example, if your employer offers a 401(k) or similar workplace retirement savings plan, you would sign up and agree to have 10% (or whatever percentage you've settled on) automatically deducted from each paycheck and invested into your account. Indeed, since employers often match employees' 401(k) contributions — typically contributing in 3% to 5% of pay — you can significantly boost the amount you save without having to kick in more money of your own.
If you don't have access to a 401(k) or other savings plan through work, then sign up for an automatic investing plan that transfers money each month from your checking account to a money-market fund or other mutual fund account. You shouldn't have any trouble finding such a plan as most fund companies offer them.
One way or another, though, the goal is create a system where money goes from your paycheck or your bank account into a savings or investment account without you having to do anything. Once you've set the process in motion, you want your savings program to operate on autopilot. If your savings plan relies on you having to make a conscious decision such as writing out a check each time you save, your odds of building a considerable pot of savings will decline dramatically. There's just too high a risk that you won't follow through, whether it's because you forget to do it or you find some way to spend the money rather than save it.
If you haven't been saving on a regular basis, going immediately to a 10% or 15% savings rate might prove too much of a shock to the system. In that case, start with a level of savings you feel you can manage, say, 5%, and then increase it by a percentage point a year until you get to 15%. If you embark on such a strategy early on and stick to it as your salary increases throughout your career, you can more than double the amount of money you'll have at retirement compared with what you'd have sticking to a 5% rate.
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Another way to gradually boost your savings while minimizing the strain on your budget is to up your savings rate a bit each time you get a raise. Rather than just allowing your lifestyle to rise in lockstep with your income, you might instead devote half of each pay increase to savings. That way, you still get to enjoy your higher income, but you also fatten your savings coffers at the same time.
There are plenty of other things you can do to become a more effective saver. For example, you can simply make it harder to spend by locking your credit cards away and forcing yourself to operate on a cash basis. Plus, buying with cash, which requires you to part with your money immediately as opposed to in the future when you're paying with plastic, may help you rein in spending simply by making you more aware of how much money you're actually forking over each time you spend.
Or, if you're the type who likes to look for specific ways to cut expenses or otherwise free up money to save, check out these 10 ways to supercharge your savings. And since we're in tax-filing season, remember that saving rather than spending any refund you may receive, can be a good way to supplement your on-going savings program. Last year, for example, taxpayers received an average refund of $2,895, according to the IRS.
Generally, it's a good idea to have an emergency fund equal to three to six months' worth of living expenses in a savings account or money-market fund with your savings before you begin investing in longer-term investments. That way, you won't have to tap into retirement accounts (which may be hard to get at or levy penalties on withdrawals) or liquidate long-term investments at an inopportune time should you find yourself suddenly unemployed or need ready cash for unexpected expenses.
Once you begin funneling more of your savings effort into longer-term investments like stock and bond mutual funds or ETFs, you can engage in another form of saving that won't cost you a cent — i.e., sticking to low-fee investments such as index funds and ETFs. By cutting ongoing investment costs by upwards of a percentage point a year or so compared with more expensive investments, you'll be able to earn a higher return on your savings, the effect of which over decades of savings can be akin to saving an extra percentage or more of salary each year, except that you don't have to actually fork over the extra money.
But it all begins with creating a viable plan, sticking to it and monitoring your progress over the years (which you can do with the tools and calculators here). Because if you wing it or end up saving only when you're in the mood or feeling flush with some extra dough on your hands, your chances of accumulating a sizable nest egg that can provide a measure of financial security during your career and then help you maintain your standard of living after you retire, will be greatly diminished.
