Thursday, April 29, 2010

How to save money - part 1

Saving money

In the previous post, we talked about saving money and it's importance in creating wealth. I would like to talk some more about it and explain how I save money.

Where do you start?


For people who are just to spend a lot of money, it might be difficult to figure out how to start saving. People who are in debt, will probably have trouble changing the habits that got them into debt in the first place.

I'm here to tell you that you can not change your behaviour overnight. It will cause you to rebound faster than a bouncingball bounces back, when thrown with force to the ground. It's comparable to loosing weight. You need to slowly change your habits, so you feel a gradual improvement. And the first thing you need to do, is answer the following question:
'Where do I stand?'

Where do you stand?


An easy answer would be: "I'm in debt" or "I'm doing fine". Those answers may be true, but they are not detailed enough to help fix or improve your current situation. You need to find out exactly how much money your spending and how much money is coming in. If you're in debt, there will be more money going out, so we need to find out where that money is going to.

Consider your money as a barrel. All debt is like a hole in the barrel, causing the water to flow out. You need to find the holes, so you can close them up.

Personal Finance Method 1: The Piggy Banks

If you have no knowlegde of computers and personal finance applications, a good way to determine your current budget, is to categorize everything and make a jar or a piggy bank for each category. For EVERYTHING you spend, you need to put the amount on a piece of paper and deposit it in the correct jar.

You have to start doing this from the first of the month and stop at the end of the month. Try to take a month without too much special occasions going on, an avarage month. If you have a month with a lot of birthdays, for example, you'll spend a bit more. This does not count right now. Try picking an avarage month.

At the beginning of the new month, you can then revise every category (jar) and count all the numbers of everything you spent to that particular category. Write it all down on a sheet of paper.

Make sure you have 3 columns: old expenses, goal and new expenses.
The numbers in the jars, go in the old expenses column. In the goal column, we will put a realistic budget, that will allow us to save money. In the 3rd column, we will be able to see if we can do it.

After we set a budget and put it in the 2nd column, it's time to try to live by that budget. You have to check whether you're doing this, in the same way as you determined the old budget. Empty the jars at the beginning of the new month and again, you write down everything you spent for each category. At the end of the new month, you count all the numbers in each category again. These values go on your sheet of paper in the 3rd column.

Now you can compare the 3rd and the 2nd column and see how well you did. If you count the totals of those columns, you have another interesting number to compare. This will tell you, whether you live within your budget. If total new expenses < size="4">Personal Finance Method 2: Personal Finance Applications

These days, computers can be used for anything. Managing your budget and keeping an eye on your personal finances, is no exception. It works in the same way as method 1, but you don't use jars and paper. Everything can be entered in the application, both the categories and the numbers.

This has an added benefit: most personal finance applications can generate small reports, so you can see in graphs how well you are doing. This can make your situation more clear.

If your somewhat of a computer geek or you like a simple and solid application, I recommend the clipf application. It's a free, open source python application that allows you to do everything you need to manage your personal finances and it's even capable of doing some basic reporting. Your data will be stored in a text-file. It works on the command line though, so this might not be the right application for everyone.

If you don't really know a lot about computers, you can always use a spreadsheet to keep a record of your spending. I would recommend openoffice for this, because it works well and it's free. There's a lot of information to be found on the internet, about openoffice and how to use it.
There are even templates you can use, so most of the work is already done for you.

What categories do I need to use?

This depends from person to person, from family to individual, etc. But there are a few categories that can and must be used by everyone. These include: house (rent/mortgage), house (repairs), clothes, food, hobbies, car/transportation, vacation.

You count the amount of money you pay for everything, on a monthly basis, and compare this to your monthly income. If you have one time costs, for example in the vacation category, you should take the yearly cost and divide it by 12.

This way, you can see all your expenses per month and you can compare it to your monthly income. The more categories you make like this, the more detailed you can start saving. The goal is to get each categories expense, as low as possible.

To save, you need to adhere to this formula:
(Total income per month - Total costs per month) > 0

The categories give you ideas as to where you spend too much money. Those are the places you can save, in order to meet the requirements of the formula.

But too many categories, means that you'll have too much work to do, to keep track of your finances. This will discourage you to continue keeping track of your money. So it's best to find the right amount of categories, so there's a good trade-off between entering enough data and having to put too much effort in entering financial data.

If you're unsure, just use the basic categories I mentioned above. Also note that smokers, should enter smoking as a seperate categorie. Just because it costs so much. And who knows, it might even persuade you to quit smoking, if you see how much money is lost to it?


Conclusion

You know some ways to keep track of your spending, you know how to compare the data, but what about actually saving the money? How can we go from being in debt each month, to putting money aside each month? I'll explain this in detail in the next post.