New to saving? 3 steps to a bigger nest egg

(Money Magazine) -- Question: I'm a single mom who recently went back to work after not working for 12 years. Until now, I've never been responsible for paying a single bill. I'd like to save some money, but I'm not sure how. For now, I sometimes overpay my electricity, water or phone bill, figuring if I have the money now, why not pay double? But there's got to be a better way. I'd love some advice. --Jennifer, Orlando, Florida

Answer: You've got the right instincts. You know that you ought to be saving and you're making an effort to do so. Kudos for that.

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Walter Updegrave is a senior editor with Money Magazine and is the author of "How to Retire Rich in a Totally Changed World: Why You're Not in Kansas Anymore" (Three Rivers Press 2005).

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It's in the execution, however, where you can use a bit of help. Your current method has several shortcomings. For one, you earn no interest on those overpayments, which makes it a better deal for the utility companies than for you. In effect, you're giving them an interest-free loan.

The other problem is that even if you followed your strategy systematically, money in the form of credits spread among utility companies won't serve one of the most important functions of savings -- which is to have a stash of assets you can draw on when you need it.

I don't think there's necessarily a "best" way when it comes to saving money. What works for you, may not be ideal for someone else. So I'm going to suggest a few strategies, and you can pick and choose the ones that appeal most to you. Keep in mind that all of these methods have one common requirement: You must live on less than you earn. There's no way around that fact.

Since we live in a society that revolves around immediate gratification, many people find it hard to wrap their mind around that simple truth. But with a little bit of discipline, you should be able to come to a balance of living decently today while setting aside a few bucks for the future.

Here are my suggestions:

Take a hands-off approach. One of the most difficult things about saving is that there always seems to be some current need competing for your money. Before you know it, your pay is spent and saving is put off into the hazy future.

The way around that is to arrange things so that money automatically flows into a savings account or other stash before you can get your hands on it. That's one of the big advantages of 401(k)s -- they make saving relatively painless by pulling the money from your paycheck before you get a chance to spend it.

You can apply this concept to non-retirement savings by opening an account with a mutual fund company and choosing the automatic investing option, which transfers money each month from your checking account into a mutual fund. Most fund companies offer this option, many for as little as a couple hundred bucks a month.

When you're just starting out, this money should go into a money-market fund, so it won't be subject to the ups and downs of the financial markets. The return is going to be pitifully low these days. But the point isn't to earn the highest possible return on this portion of your savings, it's to keep it secure.

Once you've accumulated about three months worth of living expenses, you can think about investing for the longer term either by directing your monthly savings to stock and bond mutual funds or contributing to a 401(k) or similar program at work, if your employer offers one (in which case you want to be contribute at least enough to take advantage of any company matching funds).

I can tell you from personal experience that this method works. For more than a dozen years I've had money automatically transferred from my checking account into a total stock market fund. Initially I felt the monthly hit, but now I don't even notice it -- except when I look at my account balance and see how much extra I've been able to save.

Give yourself an incentive. Psychologically, the deck is stacked against us when it comes to saving. The benefits of saving (financial security, money for life post-career) are abstract and off in the future, while we can enjoy the benefits of spending (new car, exotic vacations) here and now. No wonder spending wins out.

But you may be able to level the playing field -- or even tilt it toward saving -- by rewarding yourself if you put money away. Yes, it may seem counterintuitive, even counterproductive. But setting a savings target of $200 a month, $5,000 a year or whatever and then rewarding yourself with a modest prize (a nice dinner out, tickets to a concert) if you reach your goal may give you just the extra nudge you need to get into the savings habit. You can then raise the target and the reward each year.

If you respond better to a stick than a carrot, you might check out Stickk.com, a site that uses "commitment contracts" to help people save for goals ranging from losing weight to exercising regularly. The idea is that you commit to, say, saving $100 a month for the next 12 months, but agree to pay a penalty that you set in advance, say, $500, if you don't follow through. The penalty funds can go to a friend, a charity or an "anti-charity" -- i.e., an organization whose ideals don't jibe with yours. The idea is to make it painful for you to fall short of meeting your goal.

Focus on the big stuff. Most articles about saving are about how you can amass big bucks by eliminating a lot of small expenditures. The idea is that if you save, say, $10 a day by foregoing daily lattes and other snacks, your savings could total upwards of $50,000 after 10 years, assuming a 6% rate of return.

But I doubt many people would have the discipline to stick to such a regimen -- I know I wouldn't -- and besides, eliminating small pleasures can make life a little grim.

Which is why I think you're better off holding the line on big-ticket items. Opting for a used car instead of flashy new one, buying a smaller home or renting less apartment than you can afford and looking for creative ways to keep vacation costs down can significantly lower your living costs, leaving you with more extra income to save.

You may also be able to find considerable saving by cutting back on recurring items between big and small expenditures, things like comparison shopping for the best rates on insurance (and raising your deductible), re-assessing whether you need premium cable, making sure you're not overpaying on credit cards and other loans (not running up debt in the first place is even more important), etc. Sites like Mint.com, Billshrink.com and Bankrate.com can help on that score.

If turns out that cutting out lattes leaves you with lots of spare cash, fine. Go for it, because in the end you're more likely to save if you settle on a system that most suits you.

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