What's the Right Way to Save?

Photo: Uhuru

We all have our own ways of handling our finances -- and that's why it's called "personal" finance. What works for one person may not necessarily work for someone else, and this is why I find it highly interesting when people get into debates over the different ways to manage money or handle debt.  Is there really a right way and a wrong way to do things?

I will argue that there are many effective strategies to go about handling your money, even if some of these strategies may at first come across to you as being on opposing sides of the fence.  Depending on one's circumstances, one approach may work better than another.  Also, it's not unusual for your financial habits to change based on your particular situation or stage in life.  You may find that a lifestyle adjustment may prompt a corresponding change in your financial plans.

So allow me to present some interesting arguments that govern the process of saving.  There are many more debates of a similar nature to this that I've come across, but for now, I'll cover these five points on the subject of saving money.  Do you find yourself belonging to one camp or another?  I'll try my best to supply my own perspective on each question so you can see where I stand:

Is There A Right Way To Save?

1. To budget or not to budget, that is the question.
Do you budget?  Budgeting is an important step to get your financial situation under control.  If you are feeling the weight of a heavy debt load, then the first thing you've got to do is to track your income and outgo.  Where is your money going?  You can do this for free with a tool like Mint or Wesabe.  Or you can go with a solid desktop tool like this one I've reviewed called YNAB, or any one in this list of budgeting tools. While some people meticulously record every single dime they've got and apply this to their budget, some perform a more cursory process and take a lighter approach to budgeting.  I actually belong to the latter camp: I don't capture every cent that enters or leaves my clutches.  I tend to have a rough idea of my expenses and do a monthly review based on the account statements that I have.  I then enter these summaries into my budgeting tool.  I'm comfortable doing things this way because I feel that I have solid control over my spending.  Since most of my spending has been very predictable, I don't see why I need to track every item I buy from the grocery store or every dollar I spend on gas.  I've been "cutting corners" this way for years, but I've noted that this hasn't had a negative impact on my budget in the least bit.  But how about you -- how do you budget?

2. Pay yourself first or pay yourself last?
I am an advocate of the "pay it yourself first" approach -- that is, I've signed up for bill pay, direct deposit and an automatic savings program.  Paying yourself first is a strategy that involves designating a portion of your income (say 10%) and moving it to a savings fund such as a high interest account, or to a longer term investment such as an index fund.  But there are folks who evangelize the "pay yourself last" approach, which as I understand it, simply means that you save as a conscious "choice" rather than as an automatic process.  I'm actually using both strategies to some extent -- I've set up an automatic savings program for a percentage of my income, then with whatever discretionary income that remains, I may save additional money based on choice.  For more on "paying yourself last", check out Passion Saving.

3. Use credit cards to save or avoid them like the plague?
I've often declared how much I appreciate credit cards as a financial tool to help me with my finances.  I've applied to various credit card rewards programs to help me save while I spend, and quite appreciate the cash back and points I earn when I use my rewards cards.  Of course, for every person who agrees with me, there are countless others who will fervently disagree.  And it all boils down to our past experiences with credit card debt.  For those who have been heavily stung by their credit cards, it's not a surprise that they develop an aversion to cards as they work to control their debt.  Is it possible for those who've had negative experiences with credit card debt to eventually develop a more favorable opinion of credit cards?

4. Pay down debt or build an emergency fund?
For some of us, aggressively paying down debt is a significant goal.  I actually tend to fall in this camp as well, because I'm not one who likes to carry debt for long.   But if you've been following Suze Orman, you may have encountered one of her more recent tips: if you don't have any savings, she encourages you to think about paying only the minimum on your credit cards and instead, channeling the rest of your money towards an emergency fund.  The current credit crisis has prompted this new advice from Suze, who believes that we should focus on building our savings and relying on our own funds, now that card companies have become less supportive of their customers.

5. Pay down most expensive debt or smallest debt?
The quickest way (and therefore the cheapest way) to retire debt is to pay down those loans with the highest interest rates.  I tend to address my debt this way, regardless of how large my loans are, but it may be easier for some people to stick to their debt reduction program by tackling smaller goals first.  So picking the low lying fruit by first paying off those debts that are smallest in size (regardless of APR charges) may be the more encouraging option for some folks.  Which method would you prefer to go?

Given all these points, I don't disagree with any one approach to managing money.  I say: do whatever works for you, whatever's comfortable for you.  What's important is that your chosen techniques help you make good progress towards your financial goals.  What matters is how well your strategies work for your bottom line.

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Guest's picture

I've found that a very strict write-every-penny-down budgeting system allows me to pay myself twice. First when I take out my "base level" savings (about 7% of my take-home pay) and then later, after I've accounted for every penny I've spent and have a (sometimes) big chunk of money sitting in my checking account that didn't go to other things. All of that either goes to student loans, once every few months, or directly into savings.

Writing down every penny works for me to build up an additional savings amount I can throw in the bucket at the end of the month and no "makeup" spending on things like eating out or clothes just because I didn't get around to spending the budgeted money earlier in the month.

Guest's picture

I had a problem with credit card debt throughout my twenties and spent the better part of my thirties resolving it. I do have a positive relationship with credit cards because I realized what drove my initial problems:
1. I did not understand that minimum payments could go up a lot, interest rates could increase, and that my credit lines would not just keep going up and up like they did the first couple of times I approached my limits.
2. I falsely believed, due to the way I was raised, that having debt was just something adults did.
3. I also falsely believed that having good credit was like getting an income extension. I was still in school mode...if your grades were high enough, you got to skip the final! If you pay your bills on time, you get extra money!
4. My parents were unsupportive of me financially as an outgrowth of their lack of emotional support, and also relative to those of my friends at school. I used credit cards to match my friends' lifestyle because not having the things and experiences they did was like rubbing salt into an open wound. I tried to replace parental love with credit lines from Chase, Citibank, anyone!

Now I have three credit cards, each with a specific purpose, and I pay my debt in full each month unless I have a specific reason not to...such as beefing up savings, as per Suze Orman...and in that case I still have a realistic timetable and plan for how to keep the balance low and eventually pay it off. I had to address the emotional and the factual issues first, though. If I didn't understand the facts, I could have messed up without any emotional issues. If I understood how it all worked but was still trying to replace love or buy adulthood, I would still be getting in trouble.

Guest's picture

Unfortunately, my employer doesn't do direct deposit. It's not too big of a hassle, because my bank (USAA) let's you scan your checks and deposit online, which is really handy. But I don't really go for the "pay myself first" thing. I get paid once a month (which is a pain) so by that time, I've gotten all my bills. I typically pay all my bills with a credit card (small rewards, but every little bit helps) so at the end of the month I pretty much just have my rent and the credit card bills. I could take a portion of my check and "save" it immediately, but if the remainder isn't enough to cover the bills, I have to take it back out of savings anyway.

My financial strategy keeps shifting. When I had to buy a new (used) car because my truck died beyond fiscally reasonable repair, for the first year I focused on paying down the loan. It's a five year loan, 4.9% (thank you, credit history) and about $270 a month. I've since read about focusing on the total cost instead of the monthly payments, but my reasoning is that that pitfall only really applies if you're only going to be paying the minimum. With the lower payment, I can easily pay down the loan, while still having wiggle room if my financial situation changes. I think it's better to be able to pay $500 optionally on a $270 payment than it is to have to pay $500. Since then, my job situation seems less certain, so I've shifted to paying the minimum payment on the car and focusing on building my emergency fund. But that first year of overpayment put me about a year ahead on my car, so If it really hits the fan I can go about a year without making a payment, according to my bank. At the same time I'm trying to save some money separately to invest, which I'd be doing now if the funds I'm looking at didn't have a minimum initial investment.

All in all, I think I'm on the right track. It just seems to go so slowly.

Guest's picture

I agree, everyone has their own way of dealing with debt, which is why there are so many websites, blogs, and companies dedicated to this area of expertise.

Guest's picture

"Is it possible for those who've had negative experiences with credit card debt to eventually develop a more favorable opinion of credit cards?"

I would have to say yes to that, at least in our case. We got into so much trouble eons ago with cc debt that we ended up in bankruptcy court. That was followed by years of staying vehemently away from credit cards. UNTIL we were in the enviable position of being okay-off financially and with the understanding that any cc use would be paid off in full each month, never again would any cc we have carry a balance. With that hard and fast rule in place, we now have a Upromise cc from BofA that has helped us accumulate about $1500 in "free" rewards money towards our son's college tuition bills. When he's done with school, we'll use a different card that rewards us in some other way (like my Starbucks cc - can't ever have too much coffee :) ). So it is possible to overcome the aversion that cc debt usually leads to. But it takes work, time and commitment, like most everything else worth achieving.

Guest's picture

I am working on paying myself first. I always end up dipping in my savings though. I hate doing this! I need to work on not doing this.

Guest's picture

That's part of the reason I pay myself last. On a bad month I may not hardly get to put anything away in savings, but it saves me the negative psychological effect of having to pull money out of savings when it comes time to pay the bills.

Guest's picture

Great post!

Hands down, I have found that the best way to save is to do it automatically. You learn to live on what your pay is after you pay yourself. If you don't put some money away first, you will always end using it for something else.

Guest's picture

Regarding point #4, emergency fund or pay down debt. I lean in favor of savings before debt.

I had an old friend many years ago who said, "your view of life is very different if your vault is full".

Savings--the full vault--can give you the sense of strength and security you'll need to even begin paying down debt in a meaningful way. The ability to save provides tangible evidence that you can live beneath your means, which paves the way to pay off debt.

Guest's picture

My current preferences pretty much align with yours, Silicon Valley Blogger, although some strategies were different when my income was very low and I lived much closer to the edge.

I'd say it is possible for people to change their relationship with credit cards for the better. My husband is, nowadays, an extremely level-headed guy when it comes to finances. He refinanced his house not long after we started dating, and he was pretty proud to show me his 820 credit score :-) I never would have guessed he had trouble in the past, but recently he confessed that in the days not long after high school he actually did get into a bad CC debt mess.

He took over the housecleaner's job at his parent's house for about a year to earn extra money and dig himself out. He's kept his finances in order ever since--I think to avoid having to repeat such an unpleasant and embarrassing situation!

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Guest's picture

We are of the budget-everything-mind-set for the most part. Our finances are tight, so that makes sense for us. Savings is taken off the top.

Guest's picture

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Guest's picture

Capital One recently raised my interest rate from 8.9 to 17.9. When I called and asked why, their response, "It's not you, it's the economy." I don't have much of a balance, but suddenly those finance charges are eating up a lot more money than I care to give them. I'll save when they're paid off.

Guest's picture

I am in the camp that saves before paying down debt. This is a recent development for me. I used to always pay down my debt first. Here's why I changed my strategy.

In the past six months I've had a few friends who paid down their credit cards with very large lump sum payments. The credit card companies then lowered my friends' credit limits! So now these people don't have that cash, AND they don't have that credit either. Credit card companies seem to be doing this more and more. I understand why... they don't want to write off any bad debt.

So that's why I'm in favor, at this time in the credit crisis, for people to save before paying down the debt. I'd be scared to not have the cash OR the credit.