How to Save More

Originally published in MoneySense

July 2012

Whether you love budgeting or hate it, you can save more. Finding the right approach makes all the difference.

Saving is a lot like trying to lose weight. You promise to eat less, avoid bad foods and exercise more. Then you start to slack off, you loosen your belt and before long you're back to your old habits, trying to figure out where it all went wrong. If you've ever opened your bank statement and wondered where on earth all your money went, you know the feeling.

But saving isn't as much about cutting back as it is about taking control of your cash flow. You start by making sure your obligations are taken care of - your bills, rent, and mortgage payments. Once you have a handle on your cash flow, you will have a better idea of how much you can save and spend each month without going into debt. It's a liberating feeling.

Simply making more doesn't necessarily mean you'll save more. "It doesn't matter if you make $50,000 a year or $500,000 a year, if you're spending more than you're making, you're not managing your cash flow properly," says Rick Coyle, a fee-only advisor in Kemptville, N.S.

Regardless of how much you make, drawing up a budget can be tough, and following it can be even tougher. Luckily, there are two proven cash management approaches that will make you richer: the top-down approach, where you set a budget and stick to it, and the bottom-up approach, where you pay yourself first and spend the rest. Both methods are effective, but it's important to pick the strategy that works for you. "It's a personality thing," says Coyle. "I have clients who budget every penny. They're analytical, detail-oriented people who thrive on having control. Others are not that way."

If you're more disciplined, then the top-down approach could work for you. Start by collecting receipts and tracking your spending in a diary to see how well your spending matches your income. "A lot of people don't know what they spend," says Pat White, executive director of Credit Counselling Canada in Toronto. "Until you know where the money's going, you can't do a budget."

The next step involves figuring out the most effective way to use your money - how much goes to groceries versus how much you put towards savings. The top-down approach forces you to decide in advance how you are going to spend. If you find you are spending more than you've allocated to any one category then you know immediately where you need to cut back.

To help keep track of it all Sheila Walkington, co-founder of Money Coaches Canada, recommends the bucket approach, with each bucket representing a bank account. You'll need four in all. The first one is for untouchables like rent and utilities. The second is for regular monthly spending - groceries, gifts and gas. The third bucket is set aside for saving for the future, and the final bucket - the one that gets most people into trouble - is for irregular expenses, those once- or twice-a-year bills that aren't predictable on a monthly basis.

Most find the fourth bucket the hardest to manage, but there are steps you can take to make your life easier. Start by adding up all of those irregular expenses from the previous year - your car maintenance, your home insurance and travel - and then divide that number by 12. So if you're spending $6,000 on irregular living expenses, $500 a month has to go into that fourth bucket to provide for future expenses.

Next, ask yourself if there are areas where you can spend less so you can pay your debt down faster or save more money. Often those savings come from places where you least expect it. "It's not the big things that surprise people," says White. "It's the groceries, coffees and eating out."

To make sure you reach your savings goals it helps to have a calendar that shows when you get paid and what money is coming out of your account. Having a reward at the end is also beneficial since it helps you keep your eye on the prize. "Most people budget to achieve financial independence and security," says Darryl Robinson, a fee-only financial planner in Selkirk, Man. "It's like giving up that second piece of cake. Why do you do it? So you can get into that dress. There will be a reward in the future. It's psychological." If you need some help budgeting, you might try some useful online tools and apps to help get you started, such as Jumsoft's Money, iReconcile or MoneyBook.

If you're the type of person who has difficulty tracking your spending then following a budget may not be for you. You're more likely to succeed with a bottom-up approach to saving. With this method you decide how much you want to save in advance, then set up automatic transfers to a regular savings account or to a high-interest savings account that lets you take advantage of compound interest to grow it even faster (see "Savings accelerator," above).

For instance, you could decide you want to save 10% of your gross (before tax) income every year. To do that, you could simply set up an automatic withdrawal that coincides with your payday to redirect that money into a savings account. The money is saved automatically so you never see it, and you're never tempted to spend it. (You can also set up automatic payments for your monthly bills, and you'll never pay another late fee.) The money that remains is yours to spend, guilt-free. "But be careful," says Robinson. "You don't want to be saving 10% of your salary every month while you're still racking up debt on your credit cards. You're not likely to reach your financial goals if you're doing that."

To make this plan work, make sure you pay off your short-term debt, including credit cards, in full every month. Your financial advisor can help you manage your cash flow better by helping you set up a budget as part of a long-term financial plan.