What is the best way to save money and how do you get started? It could be especially hard to save if you have low income and a couple of loans holding you back. Here are a few guidelines and recommendations that should be useful for people who are just getting started with saving money.
“Do not save what is left after spending, but spend what is left after saving.” –Warren Buffett
1. Start a budget
Some would say that the only way to start saving money is to figure out how much you earn and what you spend your salary on. That’s called budgeting. And the advice is sound, but it’s not really clear how to put it to use. Is it better to scribble everything down on paper or to master Excel and create your own spreadsheets? I’d give you two weeks tops before you give it up.
Instead, try one of the many free budgeting software options (e.g. Mint, Personal Capital, YNAB). They’ll help you kill not two, but five birds with one stone. You’ll be able to:
- Track where your money goes
- Set specific financial goals
- Track progress on those goals
- Look at trends and analyze income, spending, and debt over time
- Visualize your net worth
In the end you should be more aware of how your money is spent and where it is invested. A budget will help you catch and eliminate those pesky monthly fees. Finally, you will significantly increase your savings and grow your investment portfolio, ultimately becoming financially independent.
2. Decide how you are going to save money
There is a plethora of information available on the internet about how to save money. The question isn’t which methods are the best. The question is which ones work for you! Here are some strategies you could try. Feel free to adjust the numbers as necessary to suit your needs.
You could save money by transferring a certain amount of your salary to a different savings account on a monthly basis. The percentage you save is up to you. Some people save 10% others save as much as 80% of their income. Of course, if you’re aiming to save money fast, it’s best to aim for the highest possible percentage.
For comparison, over the last five years, I’ve managed to save an average of 65% of my salary. This is without any real frugality, and in the same time period, I’ve also taken six vacations outside the country. If I can do it, so can you!
If you’re just getting started and aren’t sure how to begin saving money, start with 1%. This will give you a taste of what it’s like, and won’t be too much to abandon the process altogether. Increase the percentage over time until you reach a comfortable savings rate that you can stick with long term.
This strategy is appropriate for people who find it daunting to part with anything that resembles a large sum. Set aside a small amount, say $5, every day. You may also set up automatic payments or make it a morning routine. The important thing is that it should be an amount that you won’t really notice much.
Incremental savings game
Who said you can’t have some fun while saving money? Why not turn the process into a game? With this incremental savings game strategy you would deposit funds gradually. Start with $1. Every day, increase the amount you save by 50c (day two would be $1.50, day three $2, etc.)
See where this is going? After a month you will have almost $250 saved. If you increment by $1 per day you’ll be at $465! Each month, reset to $1 and start over. If you like this one, keep using it. If it’s too much work, you may want to “graduate” to one of the simpler methods above.
Note: Use automated deposits
People are often put off by the mere idea of “deducting” something from their paycheck. It can be difficult to set aside a part of your salary after it has been cashed. Formally, this is known as “paying yourself first”, but it’s hard to call it that in practice if you interpret it as something being taken away.
The way to avoid this psychological trap is to set up direct deposit with your employer (if possible). Then you can have an automatic transfer of a percentage or a precise amount to a savings account. This practice has the added benefit of keeping lifestyle inflation in check as you’ll learn to live on less.
Common pitfalls to avoid when trying to save
- Don’t set the bar too high! You may have read online that you can save 30% or even 50% of your salary and have been attempting to follow these guidelines without luck. If your life is miserable because of that you would quickly stop saving altogether.
- Don’t borrow from your savings! Make it as hard as possible for yourself to withdraw from your savings account. Open a separate bank account or even a CD which you can add to. Any attempts to borrow a little now, and deposit it back next month, almost always end poorly.
3. Set up goals if you want to save money
Trying to save money without having an actual goal is a proven way to fail. Setting a goal without a deadline is another. Do the following:
- Define at least 1 goal to save money for (e.g. house down payment, car, vacation)
- Have a rough estimate of the amount you want to save
- Determine the time frame and give yourself a deadline
- Calculate the approximate monthly amount to save and adjust as needed
4. Practice saving
This one may seem silly to you, but if you’ve never been able to save any amount of money before, it may be necessary to aim low and get some practice rounds in. Start with an amount that cannot be saved in a month, but you can collect it in a few months.
- Home office improvements (computer, monitor, desk, chair)
- High quality clothing (e.g. a winter coat. Check brands with lifetime warranty.)
- Useful hobby equipment (camping/hiking/winter/water sports gear)
Ideally the purchase should make you happy but it would also be great if you can buy something that you can use for a very long time. This should help associate saving with powerful positive emotions.
5. Forget about impulsive show-off purchases
Just be careful not to fall into the frivolous spending and lifestyle inflation trap. James Franco famously said that “rich people nowadays wear torn jeans and Converse, while poor people wear LV and Gucci”. Don’t be like the poor people. Spend your money on things that actually matter and that can make a difference in your life. Hint: A $5,000 watch is not one of those.
6. Don’t borrow from your savings
If you can, open a deposit without the possibility of withdrawing funds, so you won’t be tempted to spend the money early. Remember your goals, and stick to them.
7. Destroy any and all debt
This is not so much advice on how to save money as a warning against a common mistake – getting into debt before you’re ready. Credit card debt counts. Use your credit cards wisely. If you have debt, it may be very hard or nearly impossible to save, because you are almost never paying only the amount you borrowed. You are paying interest on top of it, which may be quite a bit more than you think.
For example, if you take a loan of $20,000 to buy a car at 5% interest rate over 5 years, you may think you’ll pay just an extra $1000 in interest (that’s 5% of $20K). In reality you will actually be paying $2,645 in interest to the lender, because of something known as compound interest.
As Albert Einstein reportedly said, “compounding is the eighth wonder of the world. He who understands it, earns it. He who doesn’t, pays it.” In the case of debt, you are paying it. The larger the loan and the longer the term, the more interest you’ll pay to the lender.
Therefore, early repayment of debt should become your first goal. Don’t even bother setting any other goals until this one is achieved. To reduce payments and speed up the process, make sure to use offers to refinance loans and mortgages. And once you pay off all your debt, try to be on the beneficial side of compounding in the future.
Take the time and learn how interest rates work. Look up how much interest you will pay over the term of any loan you have. That’s money you’ll never see again.
8. Multiply your money to build wealth
Once you’ve paid off all your debt and managed to save some money on the side for emergencies, you are ready to look into investing. Think of your money you’ve managed to save as your loyal employees who work for you for free. You can assign them to work on different projects. Some will be more profitable than others, but overall they should make you more money.
The important thing to learn here is that this time compound interest is working in your favor. This is the end goal! This makes it possible for you to make money while you sleep. It allows you to retire and continue to receive a paycheck from your own investments, rather than from an employer.
With that in mind, you should set aside a percentage of your monthly income to invest for your future and start educating yourself about the different investment tools that may be available to you. Here are some of the most popular ones:
- Retirement investments – 401k, Roth IRA
- Stocks – US and Foreign, Index Funds, ETFs. Instead of picking individual stocks, I’d recommend sticking to ETFs and Index Funds with low expense ratios (I like Vanguard’s funds).
- Real estate – you could buy a property and rent it out, invest in REITs or real estate crowdfunding (I personally use and like Fundrise since it doesn’t require you to be an accredited investor).
- Bonds – less profitable, but safer investments
- Cryptocurrency – the most volatile of all. You may become a millionaire but you may also lose all of your hard earned money.
As a general rule of thumb, the younger you are the higher your risk tolerance with your investments, the bigger the potential gains. That said, never put all your eggs in one basket, and never invest more than you can afford to lose. It’s always a good idea to diversify your portfolio.
9. Start saving now
Fortunately, saving money is not rocket science. You don’t need to go to school to learn how to improve your personal finances. All you need to do is to take action. Go through this post starting at the beginning, make a coherent plan, and start implementing it today.
Here’s the optimal order/priority for your savings goals:
- Pay off your debt
- Create an emergency fund
- Invest and build wealth
- Save for better life comforts and entertainment (house, car, vacation, etc.)
Don’t get scared by seeing life comforts being last in the priority list above. Remember, the more you can invest, the higher your net worth, the better your life comforts overall!
If you have a hard time with this one, here’s a reminder of a famous quote by Warren Buffett: “Do not save what is left after spending, but spend what is left after saving”. If you can create some good habits now you will be that much better off financially throughout the rest of your life.