Friday, April 30, 2010

How to save money - part 2

The best way to save

In the last post, I talked about personal finances and how to keep track of them. Now it's time to talk about ways to save money. As a bonus, I'll give some information about what you could do, when you're in debt and want to get out of it as soon as possible.

Saving Method 1: The Piggy Banks

There are many ways you can save money. I will start with the most obvious one: putting coins in a piggy bank. I used to do this when I was little. It's a good way for children to learn how to save money. But there is a problem with this approach: the money in the piggy bank, is not doing anything. It sits there, waiting to be spend. And if you don't spend it, nothing else will happen.
Actually, this is not true. Money devaluates. The money you have now, isn't worth as much within several years. The reason for this is inflation. Everything gets more expensive. That's why they give you index adjustments in your salary. To cope with inflation. I don't quite understand the reasoning behind all of that, that's beside the scope of this article.

But what you should remember is this: the money you have now, will not be worth as much within several years. Money devaluates.
So we need a way to keep our money up to date with inflation. Or better yet, we need to overcome the inflation rate.

We can solve this in 2 ways:
  • Make sure we have enough money, so when inflation eats part of our money, the amount that's left is still enough.
  • Make sure the money we aren't using is still growing, by gaining interest.
For the piggy bank, the only thing we can do, is to add to the pile. This means that if you want to have more money and/or save more money, you need to put more of the money you get from working into the piggy bank. Your salary is automatically adjusted to inflation, so in this case inflation is not a problem. As long as you keep working.

If you want to save more, you need to be resourceful. Look at your financial data, look at the categories you made in the last post and see where you can cut back on your expenses. It'll fill your piggy bank faster.

Saving Method 2: the bank

When you put your money in the bank, you get some interest. But you also have to pay for basic services and inflation takes part of the money. So in the end, keeping your money in the bank levels out and thus it becomes comparable to the piggy bank method.

There is an added difficulty, however: extra services. You can get extra services, like credit cards, phone banking, etc. It's important to take only the basic package. Every extra service you take, will cause the bank method to cost you money. If you don't need e.g. a visa card, don't get it. It'll cost you a yearly fee. No matter how small those fees may be, with the basic package you almost level out. This means that the bank method does not really cost you money, but you don't gain extra money either. Expenses compensate for the low interest rates.
If you take the basic package, all you need to do to save money is work and add to the pile, just like with the piggy bank method.

Note: A savings account, gives a bit more interest. So when using this method, it's a good idea
to put the money you don't need to pay the bills, into the savings account. It might give you a small advantage.

Saving Method 3: funds

The stock market is a dangerous and scary place to put your money, if you know nothing about it. You can also put the money you don't use, in funds. Funds are basically a collection of stocks, managed by an employee at the bank. They guarantee you an approximate value in interest and your money back, if you keep the money in the fund for a predefined period.
This is interesting, because the interest rates are higher than those of the savings account. So you'll be saving even more money if you put your money in there. So what's the catch? It's simple: they promise you e.g. approximately 10% on your investment, while in reality, they try to make 20%. The remaining 10% goes directly into their pocket.
To get that remaining 10%, you'd have to look at method 4.

Saving Method 4: the stock market

There's a lot to say about this, but I'm gonna keep this simple. If you buy and sell stocks, you can earn money. You can also loose money. If you study enough and know what you are doing, you can earn money money than you loose. This method can give you the highest possible interest rates, but that is entirely dependent on your actions, your knowledge and your mentality.
The stock market is not for everybody, especially not those that let their emotions interfere with their money making. But it's a good way to make a lot of money.

Other saving methods

There are more ways to save money. I don't even know them all. But it all comes down to the same basic principle: spend less than you earn. The last methods above, are for maximizing your interest. But this is just the icing on the cake. It's not a necessity for saving money.
Look at your budget, try to follow it. Adjust it when needed and finally: spend less than your budget says. The less you spent, the more you are saving.
Keep it simple. If it's too difficult, it can get out of control. If it's simple, you know exactly what's going on and then you know where you are going.

Bonus: How to get out of debt

I said a lot about saving and I kept it simple. But some people may think that it's not simple at all. Those people might have debts. Sometimes, those debts will get out of control.
The same basic principles still apply, you just have to look at it differently. The less you spend, the quicker you'll be out of debt.
There are two methods of getting out of debt, that I recommend:
debt snowball and debt avalanche.

Debt snowball

This is a method for paying off your debt, where you take the smallest loan first, pay that off and work your way up.
Steps:
  • make a detailed list for all the debts you have
  • add the amount of interest you have to pay for each debt
  • put the list in ascending order
  • pay the biggest amount possible (according to your budget) for the debt with the lowest interest, pay the minimum for all others!
  • when the smallest debt is paid off: repeat
Pros:
  • it's the fastest method for paying off debts
  • it goes faster in the beginning, so the impatient are less discouraged, because they see the changes quicker
Cons:
  • it's not the cheapest way to pay off debt

Debt avalanche

Even though I have no debts to pay off, this is my favourite method. It's almost identical to the previous one.
Steps:
  • make a detailed list for all the debts you have
  • add the amount of interest you have to pay for each debt
  • put the list in descending order
  • pay the biggest amount possible (according to your budget) for the debt with the biggest interest, pay the minimum for all others!
  • when the biggest interest debt is paid off, go on to the next one and repeat
Pros:
  • the longer you are paying off debts, the faster the debts will dissappear
  • it's the cheapest method for paying of your debt
Cons:
  • it takes longer for debts to dissappear in the beginning, which may be discouraging for the impatient
  • it takes longer in total, to get rid of all debt
To me, cheapest > fastest, that's why I prefer this method.

Conclusion

You can now manage your personal finances, you know several ways to save money and you know how to pay of our debt. You also know the basic principle that always helps to save money: spend less than you earn.
Remember to keep it simple and save well... good luck.