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Budgeting and strategies for saving

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Some time ago, a financial advisor who was helping me figure out what to do with a small inheritance remarked that I have a special talent for accruing savings by bits and pieces. Well, that does appear to be the case. As we noted the other day, by the end of this year my emergency fund will exceed $24,000—above and beyond the $21,000 squirreled away last year to pay off the Renovation Loan for the downtown house. 

So…how d’you do that?

Truth to tell, I don’t know how others would do it. But here are the basics that work for me:

1. Get out of debt and stay out of debt.

At the outset of my financial journey, I paid off a five-year car loan in 18 months by adding principal prepayments to each regular monthly payment. This freed up the $300/month payments to put into savings. Within a few years, I also paid off the $80,000 mortgage on my house, partly by renting space in my home and using the income to deal with the mortgage.

Debt consumes an enormous amount of your income. Freeing yourself of debt payments effectively “increases” your income even if you never get a raise—you end up with more money to spend or save.

2. Build savings into your budget.

“Pay yourself first” is the operative principle here. This is another way of saying “spend less than you earn.” As I was paying off car and real estate loans, I also set aside a small amount for savings each month. Bare minimum has always been $200 a month. As debts dissolve, some or all of the amount you’ve freed up by paying down debt can be added to the monthly savings.

When you create a budget, an effective way to create savings is to find a place to put every dollar of income. In other words, rather than estimating what you spend on each category (such as food, housing, utilities, transportation) and stopping when those categories are accounted for, build a set categories that will account for your entire net income. One of the categories should be “monthly savings.” This approach is sometimes called “zero-based budgeting.” 

My own approach to budgeting was to carefully track expenditures for a month or two, using Quicken or Excel. This provides a picture of where and how much you’re spending. Expense categories become evident after a month or so of observation. This exercise not only allows you to see where your money is going, it gives you some clues to where you might rein in unruly spending habits (for example, have you run amok at restaurants? did you really need all those clothes?). 

Once I understood my spending patterns, I established reasonable amounts for each category, including a category for savings. Any difference between income and expenditure was added to the “savings” category. Raises in pay resulted in raises in savings; although I might not devote the entire raise to increasing saving (you do have to get a life sometime, after all), I did pay myself better savings on the rare occasions the university gave me an increase.

3. Build side income streams.

Find ways to earn above and beyond the income from your day job. A master’s degree in anything will get you an adjunct teaching job at a community college. Night courses are a lot of fun to teach, because they’re full of adults who are there because they want to be there. Such gigs are not well paid, but every buck counts. I put all my net pay from teaching directly into savings.

You’re not forced to stop with just one side job. If you have a marketable hobby, if you enjoy collecting junk and selling it in yard sales, if you can trade a skill or a product for someone else’s skill, products, or dollars, you can create income that also can build your savings account. In addition to adjunct teaching, I also indulge in freelance editing. Every penny that comes in from that endeavor goes…yep! Right into savings.

Besides helping to build savings, secondary income streams have an enormous potential benefit: you still have them if you’re laid off your day job. Having the experience and contacts in teaching and editing will allow me to ramp up both those enterprises in my coming enforced retirement, and, as we have seen, will support me in the manner to which I intend to remain accustomed even if I never get another full-time job.

4. Take full advantage of your employer’s 401(k) or 403(b) plan.

If your employer  matches contributions to a retirement plan, for heaven’s sake, go for it! Every dollar your employer puts in means twice as much long-term savings for you. 

Allocate these investments intelligently, putting 50 or 60 percent in stocks and 40 or 50 percent in bonds and the money market. You have to assume some risk to make money in your investments; keeping it all in so-called “safe” instruments means your total savings will not keep up with inflation. Though the market does drop every now and again (sometimes with operatic drama!), over time losses and gains level out and and your investments build principal. Put your money in low-load funds to the extent possible (if your employer allows you to invest with Vanguard or Fidelity, these are good choices), because management fees eat into profits at an amazing rate.

Outside of an employment-related plan, go for Roth IRAs. Although these are after-tax instruments, they have the advantage that withdrawals after you reach age 59 1/2 are tax-free, which is huge. Also, they allow you to pass money to your heirs without the nasty tax gouges inherent to 401(k) plans and traditional IRAs. Here, too, set up your IRA with a low-load provider such as Vanguard or Fidelity.

5. Cultivate a frugal lifestyle.

Try to stay sane about this. You don’t really have to live like Our Hero, Scrooge McDuck. But on the other hand, neither do you have to live like an investment banker riding high. Get over the temptation to buy every new gadget just because it’s out there; to accrue stuff because all your friends, relatives and neighbors accrue stuff; to own bigger things and more things than you really need. Learn to distinguish between want and need, and then train yourself to appreciate the nonmaterial riches of life.

Frugality and simple living are the keys to living within your means. Spending less than you earn makes it possible to build savings and, eventually, to achieve financial freedom.

Saving: Every little bit helps

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The other day, J.D. at Get Rich Slowly posted an interview with his real-life “millionaire next door.” In a very interesting article, he made the point that you don’t have to earn a Wall-Street salary to accrue enough wealth to achieve financial independence. John, the interview’s subject, did it on a teacher’s salary. The trick, he says, is to spend less than you earn.

True that. I would add that it’s crucial to build your budget so that you do spend less than you earn by including a line item for savings, and then to foster the habit of saving everything else that you don’t spend on living expenses. Even if you’re fighting to get out of debt, at least some small amount of your total income can go into savings. Paid Twice sets the example for this strategy: despite setbacks such as the car crapping out, she and her husband persist in building emergency fund savings while beating back a debt load that started out at a depressingly large figure.

Thanks to the collapse of the Bush economy, I’m no millionaire, but I’m a great deal less perturbed about the pending layoff than one would expect, because I have plenty to live on despite the obligation to help with the mortgage on a second house. The mortgage on my own home is paid for and I have no other debt except a $21,000 loan taken out to renovate the downtown house. Suspecting the university would can me, I started setting aside enough money to pay off that loan last year and for the past several months have had enough to kill it. The reason I haven’t paid it off is that I felt I should hang onto the cash to make it double as an emergency fund in the event I lost my job.

I have, however, decided that next week I will pay off the Renovation Loan. Why? Because by the end of this year I’ll have saved another $24,000! That’s after setting aside enough to cover COBRA until Medicare kicks in and after paying the $1,200 for my car’s 90,000-mile service.

That will have happened because I don’t spend anywhere near what I earn.

First, I’ve always engineered the budget so that $200 a month goes straight to savings. While trying to accrue enough to pay off the Renovation Loan, I budgeted another $204 toward that (started out more, but GDU’s furlough days cut my net income by $180 a month). Once enough was saved for that purpose, I just kept on putting the extra amount in savings: a total of $404 a month.

Second, I have two side income streams, freelance editing and teaching. Every after-tax dollar from those activities has gone into savings. These income sources made it possible to accrue enough to pay off the second mortgage by the end of last year.

Having cut spending by $180 a month, in August when the furlough days end (so we’re told…), I’ll continue to put that much in savings, too. I should net about $5,000 from the three community college courses I’ll teach in the fall, and a conservative estimate of freelance income is about $200 a month, for a total of $1,600 between now and layoff day.

Staying on budget has allowed me to spend less than I put into the credit union accounts set aside for recurring expenses and for credit card charges (I charge everything other than monthly bills on the American Express card, pay it off each month, and collect a kickback of between $250 and $500 at the end of AMEX’s fiscal year). This means a fair amount has accrued in accrued in dribs and drabs and is just sitting in those two accounts. Here’s how that shakes out:

savingsfigs5-3-09

Projecting the amount the regular savings from my GDU paycheck should grow, by December 31, layoff day, I should end up with almost $5,800 to add to existing credit union savings:

savingsprojected12-09

Okay. Now let’s add to that the amounts I figure to net from teaching and freelancing, to arrive at the projected 2009 savings as of December 31:

savingsincprojected12-09

Amazing. The $12,380 I expect to squirrel away from net teaching and editing income plus routine savings from my GDU paycheck plus the $11,931 already on hand comes to $24,311.

That’s with a pretty conservative estimate of freelance earnings, and it doesn’t count the so-called “extra” paycheck coming in July, thanks to the crazy bimonthly pay schedule. Add another $1,200 (some of the “extra” paycheck has to be used to cover regular spending—it’s not really extra) and the vacation pay GDU will owe me in December (around $2,600) and you come up with a projected total of something over $28,000.

This will be my fallback fund in retirement. If utilities and healthcare bills exceed a given month’s income from retirement savings and teaching (as they will in the summer), this “cushion” will keep me from bouncing checks.

It’s come about because I spend a lot less than I earn! Whenever I take a side job, I put the money into savings. My budget covers only the amount I make in my day job at the Great Desert University, and that budget allows for a $404 monthly deposit to savings—soon to be $574, after I pay off the Renovation Loan.

scenario-1bEven though I’ll have to spend almost everything I earn once the day job ends, I’m still planning to deposit at least $200 a month in savings. Assuming I put $10,000 of the accrued savings into my main checking account, things will be tight: in a month when I’m paid for only two weeks of teaching, I barely squeak by. However, when the community college checks come in twice a month, I accrue so much extra that unemployment during the expensive summer months will not cause spending to run the bottom line into the red. I should start August with $11,650 in checking and end it with $11,508. After that, as utility bills fall, spending money rises. After all the bills are paid in December 2010, I should have about $12,970, leaving me $3,970 in the black at the end of the year.

That’s $3,970 that will go into savings…

Frugality, savings, and the causes of doom

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Okay, I know that writing about the same thing other bloggers are posting is a form of mob journalism, much to be avoided. But what the heck… Pimp Your Finances is riding one of my favorite hobbyhorses, the argument that saving and frugality are harming the economy. We cheapskates are to be blamed for the fall of civilization as we know it.

No. ‘Fraid not.

As I was harmonizing with PYF’s rant, it occurred to me that there’s a subtle difference between saving and frugality.

Saving means setting some money aside for future use. Generally savings go into bank accounts or into other financial instruments with higher risk and higher potential return.

Frugality means living within your means: spending less (or at least no more) than you earn.

Most people who are frugal are in a position to save money; obviously, if you manage to spend less than you earn, you can take that unspent money and invest it somewhere. But some people who are profligate—who have run up revolving debt or have bought more house than anyone in their right mind could possibly claim to need—also are able to save money, if only through mandatory 401(k) or retirement fund contributions.

My Journey to Millions added a comment to PYF’s post noting that savings do not get locked in a vault somewhere. Banks loan out depositors’ savings (or so they’re supposed to do) to individuals and businesses, and that’s a large cog in the wheel that is our economy. When banks refuse to lend, as they’ve been doing in the present crunch, the economy grinds to a halt. Thus saving not only is not bad for the economy, it’s crucial to any nation’s economic health.

What short-sighted critics are saying is that frugality—which they equate with miserliness—is wrecking the economy. These are the ninnies who suggest that if we would just all hurry to the mall and max out our credit cards on junk we don’t need, everything would be just fine.

Here’s the hitch in this thinking:

When the bank owns your car, your house, your furniture, your clothes, and the dinner you sit down to at a restaurant, you’re renting your whole life and you have nothing. Although you may look affluent, the truth is you’re living in poverty. Living on the cuff creates the illusion of wealth, but it’s only an illusion.

It’s like living in the Land of Oz. Behind the lights and mirrors, our late, great “prosperity” was phony. With everyone spending until their income went mostly to service debt, no one had a REAL nickel or dime to rub together.

When everyone spends and saves responsibly, from the average person on Main Street to the A.I.G.’s of this world, then the economy will be healthy. The economy is healthy when most consumers, businesses, and lenders are financially healthy.

There’s no “paradox of frugality” here. None at all. Just a fake wizard in an Emerald City.