Editor’s note: This article was first published in October 2012, in the middle of the economic crisis in Spain; its references to the crisis and the earlier boom reflect that moment. The advice on keeping the emergency fund in an interest-bearing account assumes the interest rates available then.
A high percentage of people admit they find it very hard to save anything once they have covered their bills and expenses (some more necessary than others). In a previous article we set out 5 simple steps to improve your personal finances. The first thing is to focus on where our money is leaking out, or where we could scrape together a bit of cash, because by avoiding small daily and weekly expenses we avoid a big annual one.
Our starting point is that a euro saved is a euro earned.
1. Drop, bundle or save on insurance
If we look at our bank statement, many of us will see that a large share of our monthly, half-yearly and annual spending goes on the insurance policies we have taken out: home insurance, car insurance, life insurance and, sometimes, those small low-cost policies the bank “made you” take out back in the day to grant you a loan you are still paying off.
Clearly, many insurance policies are necessary, while others duplicate ones we already have or are unnecessary. Even so, if a family puts together all the policies it pays for (father, mother, children, vehicles, home and so on) and takes them to a single insurer, the discount it can get may be quite large. Money saved is money earned.
2. Save before you spend
In an earlier article we explained how much money we should save each month to be financially responsible (depending on your income). Often, though, the biggest problem with spending is a lack of self-control. It’s not that we are compulsive shoppers or need to check into rehab to stop buying things. It’s just that seeing cash available in our bank statements, at the ATM and so on makes us very quick to buy something we don’t really need or that could have waited.
Many of today’s millionaires say the same thing: when they had no money, they used to say, “If I had money, I’d go on a 15-day cruise.” Once they can buy not only the trip but the ship itself, they no longer feel like going on a cruise. Why? Simply because they can now afford it, and the interest fades.
So when you feel tempted to buy something (whether it costs 5 euros or 300 euros), ask yourself whether you really need it or whether it can wait. Set aside a reasonable amount of money each month for savings.
3. Prioritize your savings
We have talked before about the first thing we should do: build an emergency fund that would let us get by for at least 6 months if our income stopped.
This is the first glass to fill and, as the name suggests, it is for emergencies (the car breaks down, the roof of our home needs repairing, and so on). Although we always advise keeping the emergency fund fully liquid (so we can get at the money immediately), the truth is I’m not in favour of leaving 5,000 or 10,000 euros sitting idle without earning anything. So it’s a matter of putting that money in an interest-bearing account or, depending on your circumstances, splitting it and putting half in short-term deposits (1 or 3 months).
Once we have our emergency fund, we can move on to longer terms and start taking on some risk in our investments (controlled risk).
4. Credit debts
The dilemma is whether to save that money or use it to pay off debts. We wrote a detailed article on when it’s better to pay off debts and when it’s better to keep the money and not pay them. That said, if you have one of those credit card debts where you pay 80 euros and only 20 euros goes towards the balance, don’t think twice: get rid of it as soon as you can.
5. Save when you can
This is the lesson many people learned when the crisis began. Financial education and personal finance are now getting the attention they deserve, and we even try to save at a time when saving is hard. Had a few simple saving steps been followed during the economic “boom”, many people would not have a single money problem today; quite the opposite.
When we receive extra income, when the economic cycle is on the rise, when everyone is spending money hand over fist, that is when we should save and be frugal. When the crisis comes, that’s when we can think about buying, because prices are much lower. It’s just like the stock market: “Buy when everyone is selling and sell when everyone is buying.” And remember, the first tip for becoming a millionaire is not to live like a millionaire.
In short, we could split our steps into just two:
- Saving: Not only from the money you earn but also from the money you pay out. Write down your expenses in a notebook every day, so you can see where those small leaks are coming from, and think about how to reduce them. Ask an insurer what offer it would make you for your whole bundle of policies. If you pay account maintenance fees at your bank, find a way to stop paying them, or better still, get the bank to pay you, and so on.
- Investing: Money has to keep moving, whether in safe investments or by taking on some risk. But before investing in risky products, it’s wise to invest in knowledge so you understand those products.
Further reading
- Warren Buffett’s 10 keys to financial success
- Financial education for our children: the sooner the better
- The 5 best books on financial education
- Pension plans? I don’t think so
Featured image: Helen W. Cooke, Public domain, via Wikimedia Commons.
