3 Rules for Saving Money the Right Way

Here are three things that will get you started on the path to financial freedom.

May 3, 2014 at 1:00PM

There is no simple formula for saving money and building wealth. Everyone has different goals, incomes, obligations, and habits. However, there are a few universal rules to help you get on the right path. Do you have a savings plan? How much extra stuff do you buy? Do you save money regularly and consistently? Just by getting these three questions right, you'll be well on your way to financial security and stability.

Have a plan
Instead of saying things like "I'm going to start saving more money" or "This is the year I'll start investing for retirement," actually sit down and come up with a plan. I've known so many people who have said things like this, only to find a couple of months later that they had made no progress.

When you actually write (or type) a plan, your goal is to hold yourself accountable. If you write out your savings plan on paper, put it right on your fridge so you have no choice but to look at it. If you type it, put it right on your desktop. Force yourself to look at it often, and it'll help you get into the habit of saving quicker.

A lot of people make the mistake of not planning where to put their money once they save it. Far too many people keep all of their extra cash in a savings account, and that pretty much eliminates the biggest investment weapon you have: time. Consider that the average savings account pays just 0.07% interest. Well, the S&P 500 has averaged returns of more than 9% per year over the past 50 years! If you're nervous about buying stocks, put your money in 30-year Treasuries, which currently pay about 3.5%.

As an example, let's say you deposit $2,000 per year into an account over 30 years. In a savings account, you'll end up with just $60,613, as compared to about $103,000 if you invested in 30-year Treasuries and almost $273,000 for an S&P index fund. In the chart below, you can see my point about wasting time and money by using only savings accounts.

Growth of various savings methods over 30 years | Create Infographics.

Cut out the extra stuff
Personal-finance author David Bach called this the "latte factor," using the example of how not buying an expensive cup of coffee every morning could mean hundreds of thousands of dollars in extra investment returns over your lifetime.

Now, I'm all for treating yourself to some extent, and I don't necessarily advise following this rule as strictly as Bach suggests. In fact, I'm drinking my daily Starbucks as I type this. What I want to get you thinking about is the purchases you could live without. Let's take a look at an example.

Let's say I have an older iPad and I'm thinking about upgrading to the newest model, which starts at $499. If I decide to "rough it" with my old iPad and instead invest my $499, take a look at what it would mean to my portfolio in the 30 years or so I have left until retirement.

Growth of $499 over 30 years | Create Infographics

So, if you want to go out to dinner this weekend or take a nice vacation this year, go for it! Just think about what you're spending money on and if you can do what you want a little cheaper. By the same logic as the iPad example above, if you order a $10 sandwich instead of a $20 steak, it could mean $120 more in returns over the next 30 years. Imagine how this could add up if you chose a cheaper option even once a week!

Don't allow yourself to make excuses
Yes, you can afford to save. If you get in the habit of saving money every time you get paid, before long you won't even miss it. Treat it like another fixed expense: $700 goes into rent, $250 goes into the car payment, and $200 (or whatever amount you plan for) goes right into savings.

There are plenty of ways to set up automatic savings. Pretty much all online brokerages offer automatic recurring deposits from your bank account, with no minimum. You can deposit $20 per paycheck if you want. Mutual fund companies have similar automatic investment plans, and many are willing to waive the minimum opening balance requirement if you agree to regular deposits, and most offer target-date funds that lower the riskiness of your investments as you get closer to retirement.

It's completely fine if you only want to save a small amount at first while you're getting used to it. If you get paid every other week and save just $50 out of each paycheck to invest, it could be worth more than $160,000 in 30 years, assuming 9% returns. As you progress in your career and can afford a little more, increase your contributions.

Time is the biggest advantage you have when investing, so it's very important to get started as soon as possible. So sit down and come up with a plan for you!

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