As anyone who has started to learn about personal finance knows, one of the fundamental ideas is “pay yourself first.” Paying yourself first is an easy concept (supposedly), but many people find it hard at first to make putting money into savings a priority. Saving money sounds like a good idea, but there is always a chair that needs to be replaced, new shoes for that special occasion or just one more iTune to add to the collection. So how can you make saving a habit? It’s a trick question – you don’t have to make it a habit, you have to make it automatic. If you make your savings automatic, you never have to work on developing the habit. The habit will grow naturally once you see how easy it is.
So how do you make savings automatic? Here are 9 painless ways to do it.
- 401(k): If you work for a company, chances are they offer a 401(k); if you work for an educational institution, a hospital, a church, or a non-profit they probably offer a 403(b), and state and local government workers can invest in 457 plans. All of these plans generally offer the worker a chance to invest their wages, pre-tax, into their choice of a selection of investment options – usually mutual funds. Most plans ask the employee to set an amount or a percentage to be withdrawn every month. A 401(k) or similar plan is the single best way to make savings automatic. The contribution is not taxed and taxes are never paid on any amounts in the account. In fact, until you retire you will never pay taxes. The money is taken out before you ever even see it – so there is no temptation to cheat ‘just this once.’ Best of all, many employers match some of your contribution with a contribution of their own into your account!
- Automatically withdraw money to a savings fund: After you have contributed enough to your 401(k) plan to meet your employer’s matching limit (and more, if you can afford it) you should set up an automatic withdrawal from your checking account to a savings account. Popular options for savings accounts are high-yield accounts at ING and HSBC: even though their rates are terrible, they are better than nothing. Both will allow you to set up automatic withdrawals from your checking account directly into your savings account, where it can earn interest. You can set up the withdrawal date to be the day after your paycheck arrives, so you will not be tempted to spend that money on something else. Once the money is in a high interest savings account, it’s out of sight…, it’s out of sight, out of mind and growing rapidly thanks to the miracle of compound interest! Best of all, you can use this as an emergency fund – but only for true emergencies.
- Direct deposit your paycheck to separate accounts: If your employer allows you to have direct deposit for your paycheck, take advantage of it. Most banks will still waive monthly fees if you set up direct deposit, and if you can directly deposit to multiple accounts automatic savings become even easier. Set up two checking accounts – one for monthly expenses and one for irregular expenses. Those irregular expenses can be for any of those expenses that come up on a monthly basis that were unexpected but not really a true emergency. Maybe the tires on the car were worn, or junior broke a window playing ball. If you estimate your regular monthly expenses and have just enough money going in your ‘main’ checking account, you can take money out of the irregular expenses account without having to worry about paying the electric bill.
- Drop a penny (or a quarter) in your change jar: Keep a change jar right by the front door. Every day when you come home, throw any loose change in here. Once it fills up, take it to your local bank and deposit it in your savings. If that is too much trouble, take it to a CoinStar machine (usually at your local supermarket) and get an amazon.com gift certificate and use it to buy something useful – amazon sells many household items like CFLs and dishwashing detergent.
- Always use a credit card with rewards: This is a little more controversial, but if you have a good cash back rewards card, use exactly one credit card for every purchase you make, but pay it off in full each month! If you are the type of person who lets their credit card slip out of their wallet and into the department store’s credit card swiper by accident, I suggest you skip this step! However, if you charge $500 a month on a 1% cash back card, you can earn another $60 a year – for nothing!
- Pre-pay your mortgage: If you own a house, even adding a tiny extra principal payment can shave months or years off the length of the mortgage and save you thousands of dollars in interest. Do not let small amounts discourage you – even an extra $25 per month can save thousands in interest over the life of your mortgage.
- Reinvest dividends: If you own mutual funds or stocks you can request that dividends be reinvested. That means that whenever a dividend is issued, it is immediately used to buy more shares of that fund/stock. You never touch the money so the temptation to spend your “windfall” dividend is taken away!
- Adjust your withholding: You may enjoy getting a big tax refund every year, but if you do you have lent Uncle Sam that money for the year, interest-free. Adjust your withholding to ensure that you have as small a refund as possible. If you get a refund, the IRS gives you the option to have it direct deposited – send it to your high-yield savings account, not your checking account!
- Take advantage of FSAs: Some companies offer flexible spending accounts. A Flexible Spending Account, or FSA, is a tax-advantaged account that allows individuals to set aside portions of their earned income for public transportation, parking, dependent care and the most common type, health care expenses. Simply put, you set aside an amount you choose, pre-tax, each month in a pre-funded account and then withdraw it when you need it. You save money by taking the amount out pre-tax and putting it in an account where it can only be used for a set purpose like health care expenses. Once it is in the account, there is no way to get it back out and use it for an iPhone!
Remember: make your savings automatic and paying yourself first will become second nature!