When it comes to financial success, it's not how much you make, it's how much you save. Earning more money won't solve your financial problems if you're still spending every dime—and it won't even increase your happiness.
Nobel Prize-winning economist Angus Deaton found that making more than $75,000 a year won't significantly improve your level of contentment. He said, "More money does not necessarily buy more happiness, but less money is associated with emotional pain."
The way to stop having less money—and avoid emotional pain, whether that's not being able to treat yourself or having your cable service cut off—is to save some of it. "Money never made a man happy yet, nor will it," wrote Benjamin Franklin, a guy who knew so much about money that he's now on our $50 bill. "If you know how to spend less than you get, you have the philosopher's stone."
Frugal vs. Cheap
Learning to save isn't a matter of turning into a penny-pinching tightwad who worries about every nickel. In fact, fretting over every purchase is bound to make you just as miserable when saving as you were when you blew your entire paycheck.
Instead, set yourself one or more savings goals and methodically work toward achieving them. Those goals can be big or small, and it's good to have a mix of both. Your longest-term savings goal is to put 10% or even 15% away for retirement, and the sooner you start, the better off you'll be. But smaller goals are important because they demonstrate that savings works and mark your progress along the way.
At least one savings goal should be something that really motivates you, whether it's the down payment for a new car, a dream vacation or a designer handbag. Remember: a goal is just a dream with a deadline and a dollar sign. "I want to save $6,000 to buy a new car in three years," will do nicely.
Once you've got your goal, write it down and start saving. You don't need to create an entire budget of year's worth of spending. It's better to start and adjust as you go. If putting away $300 a month seems good, start with that amount. If that strains your budget, find ways to cut back other spending or lower your monthly savings amount and adjust your goal. If socking away that extra money doesn't pinch your monthly spending, then consider saving a bit more.
Starting small is an easy way to go. Setting aside a mere 2% of your paycheck is something you'll barely notice. On a $35,000 annual salary, that's about $40 a month after taxes, or just $10 a week. Increase that by another 2% at regular intervals, whenever you get a raise, or both, and soon enough you'll see your goal coming into view.
Another tactic for savings success is to automate your savings, also called "paying yourself first." Researchers have found that our willpower is limited, just like using a muscle. So, if you just sat through a series of boring meetings at work, your willpower for the day is drained and it will be that much harder to transfer $100 to your savings account when you get home.
Now that you've got your goal, it's time to look for the money that's going to make it a reality. For most people, that means freeing up some cash to save. One of the most effective approaches is to go through your regularly reoccurring monthly expenses. This is your fixed overhead, such as rent, insurance, debt payments, utilities and so forth. Any costs that you can cut there will give you repeated, ongoing savings, month after month, for just a one-time effort on your part.
Pick one category and look for a way to lower your cost. If you haven't compared auto insurance rates in more than two years, that's a good place to start, and you can find big savings by shopping around your cable, broadband and cell phone service, as well.
Another easy way to save is to go through your checking account and credit card statements and look at all your charges. Is there an old subscription to a magazine or online service you can eliminate? An unused gym membership or monthly fee for a buying club? You may even find extra charges hidden in your cable or phone-bill, such as a third-party answering service that was "crammed" onto your account by an unscrupulous provider.
How drastic you want to get in cutting your major expenses is going to depend on how big and how urgent your goal is. If it's crucial to save in a hurry, you may want to take in a roommate or even move. In other cases, cutting back on a few premium cable channels might be all you need to do.
To protect your savings, make sure you set aside money for your infrequent major bills, such as quarterly insurance premiums or yearly back-to-school expenses. Regularly putting money aside in a reserve account means you can pay those bills without having to make the discouraging decision to raid your hard-won savings.
To increase your savings as you go through life, avoid inflating your lifestyle whenever your income shows a significant increase. Buying big homes and flashy cars locks your fixed expenses at a level that hampers your ability to save in two ways. First, if you don't increase your saving as your income rises, you'll actually be saving a lower percentage of your income. Second, any financial emergency becomes harder to manage when your fixed expenses are high, making it more likely that you'll tap savings to make ends meet.
It takes more ongoing effort, but working to limit your variable expenses can be a much faster and flexible way to carve out cash for spending. Items such as groceries, eating out, entertainment, clothing are much more easily adjusted than refinancing your home, for example.
Even as small a change as cooking more often at home and packing your own lunch can add up, which is the idea behind the "Latte Factor," a term coined by personal finance author David Bach in his book Finish Rich. The idea is that small, unconscious spending can rob your financial future—or be harnessed to make it better. The "latte calculator" at Bach's website shows that, if instead of spending $4 per day on fancy coffee, you invested that amount at a return of 8 percent, you'd have $178,624.97 in 30 years.
Excising every little luxury from life isn't a very good way to live, and it won't provide enough money for retirement or, once you factor in taxes and inflation, even cover the entire cost of a four-year college education. But trimming some expendable spending can give you a nice vacation. The real lesson of the Latte Factor is to be aware of how you spend, direct every dollar you make, and prioritize your spending vs. your saving.
One way to control your discretionary spending is to give yourself a cash allowance. You'll tend to spend less when using real cash and it automatically limits your spending—when it's gone, you're done buying stuff until your next paycheck. Another tactic is to have your savings automatically deposited in a separate account, then use one checking account for your fixed expenses and a separate one for your discretionary spending. That way, cash is set aside for your savings and big, fixed expenses, and you're free to spend the discretionary money as you see fit.
Rather than trying to track and analyze all your everyday spending, start by scrutinizing your most common purchases. Find the cheapest nearby station for gas, the best deals on your most frequently purchased grocery items, and the dry-cleaner with the best prices. That will save you more than shopping around for items you buy infrequently during the year.
Top 10 Targets for Savings
These are the Top 10 spending categories of the average American family, according to the Department of Labor, and a few ways you can save:
Shop around your homeowner's insurance or consider a refinance if your mortgage rate is higher than current rates.
Home utilities, fuels, public services
Programmable thermostats can limit your energy use.
Food at home
There are many good budget cooking sites online, as well as grocery coupon strategies. Stocking up on groceries that go on sale and using generics can cut food costs, too.
Transportation—vehicle purchases, gas, oil
Use a site such as GasBuddy.com to find your least expensive gas station. Purchase newer used cars rather than new vehicles.
Take advantage of the tax break on a Flexible Spending Account through your workplace benefits program.
Skip cable or get a basic subscription, then get DVDs at your library and use a high-definition antenna to get local TV stations.
Food away from home
Look for specials through sites such as Groupon and restaurants with prix fixe dinner deals. Go out for lunch or brunch dates, which are less expensive than dinner.
Apparel and services
Avoid buying clothes that need expensive dry cleaning, shop clearance sales and build your wardrobe around a few good, sturdy basics. Cut your own lawn, cut back weekly maid service to twice a month and see what you can do yourself rather than hiring experts.
Household furnishings and equipment
Shop at unfurnished furniture stores, ask about clearance sales and visit estate sales.
Look for regular spending that you may not need anymore or can eliminate. Clean out a storage locker rather than paying for one every month, work out at home instead of paying for a gym.
Make Steady Progress
No savings plan is going to be perfect—at least at first. Monitoring your savings and watching it grow will keep you motivated, and so will adding up all your savings each month. Celebrate your successes but expect surprises, because you'll always run into unexpected expenses. Once you've checked off one goal, redirect that savings to a new one.