The most important financial principal in the world is to spend less than you earn. No matter what else you do, you must do this if you want to become wealthy or achieve financial freedom. One of the easiest ways to achieve this is to automate your savings. The less work you have to do on an ongoing basis, the more likely you are to get it done. Let’s take a look at how automating your finances can help you free up additional cash flow, save for emergencies, and create a cash cushion that gives you financial options.
Automate Your Savings
Saving money is more important than many people think. Why? Because money saved is worth more than money earned. Let’s explain this by asking a question: would you rather save $100 or earn $100?
I would rather have $100 that I already saved for several reasons: I have already done the work, the taxes have already been paid, and I don’t need to factor in other things such as the time value of money, inflation, or being able to physically work tomorrow to be able to earn that $100.
Those items illustrate the importance of saving money. The key is to take your surplus money every month and make it work for you. Let’s look at how you can do this.
Set financial goals. Everything starts with a goal. Why do you want to save? What are you trying to accomplish with your money? Without a goal you are simply accumulating money without purpose. The best goals are SMART goals (Specific, Measurable, Actionable, Realistic, and Timely), so include a dollar amount and a time frame to reach your savings goal. When you earn extra money, put it toward your goals.
Pay yourself first and make it automatic. If possible, set up your paycheck for direct deposit so you don’t need to worry about going to the bank every time you get paid. Some employers also give you the option of dividing your paycheck when making a direct deposit. If so, send a percentage of your paycheck to your savings account and the rest to your checking account to pay your normal expenses. Try to save the same percentage of your income every month (5%, 10%, or whatever you can afford). By paying yourself first, you lessen the risk of thinking you can’t afford it. Remember, out of sight, out of mind.
Separate your savings and checking accounts. If you put all your money in one place, it is easy to think, “OK, this is how much I have to spend.” This makes it too easy to spend money you would rather save. Maintaining separate checking and savings accounts makes it easier to save money.
Set up a high interest savings account. Another benefit to setting up a separate savings account is that you typically earn higher interest rates in a savings account vs. a checking account. You should keep enough cash on hand for an emergency fund and it’s best to have this money earning as much interest for you as possible. I currently have two bank accounts I use regularly – one with USAA and another with Capital One 360. Both accounts earn me above average interest rates on my cash.
Another idea for your long term cash savings is to build a CD ladder. Certificates of Deposit often earn more money than standard savings accounts, but the money is locked up for a specific time period. Building a CD ladder staggers the maturity dates of your CDs and gives you access to your cash more often.
Create multiple savings accounts. One of the nice features about Capital One 360 is the ability to create multiple accounts within the same user account. This makes it easy to set savings goals and create special savings accounts such as a vacation fund, home remodeling fund, or a Christmas fund. You can always do this on your own with a spreadsheet, but it’s more fun to watch the progress unfold online. And again, once the money is in one place with a definite purpose, it is easier to leave it there and avoid spending it on something else.
Save your windfalls and other unexpected income. If you have a regular income and a budget, your normal earnings are already accounted for. This makes unexpected money so much more important. Save all or most of your bonuses, rebates, pay raises, tax refunds, and other money that comes unexpectedly. Many of these things may seem small and can easily get frittered away on nothing… but when you save them, it can be surprising how quickly they add up. The concept of taking small amounts of money and adding them up is also known as “snowflaking,” and is a great way to quickly pay down debt, reach a savings goal, invest money, or anything else that you can apply small amounts of money to reach a goal.
If you have an unplanned withdrawal from your savings, pay it back. Life happens and sometimes things don’t go as planned. That is why everyone needs an emergency fund or other cash savings. It prevents you from having to rack up credit card debt, or worse, take out a payday loan. But it is important to pay that money back as soon as you can. This replenishes your emergency fund and keeps you on track to meet your savings goals.
Make saving a habit. Get in the mindset to pay yourself first, do it automatically, set goals, and watch your money grow. It sounds easy and if you are able to get a system in place, it is easy. Sure, there may be unexpected expenses that arise, but that is what your emergency fund is for. The key is to make saving a priority. If she can do it, so can you.
Photo credit: Alan Cleaver