LIFE HAPPENS: WHY YOU NEED TO SAVE MONEY

There comes a time when outside circumstances—what most people refer to as life—force us to take control.

For Harold, this moment came with the sudden arrival of his brother-in-law Vincent, which sent the household into fiscal chaos.

For most of us, however, it’s not that sudden. Money comes in, and money goes out. It seems to simply vanish, lost in a windstorm of expected and unexpected expenses. There’s rent or mortgage, car payments, and the grocery bill. And honestly, who can even make sense of the average cell phone bill?

And those are just the monthly bills and regular expenses.

Then there are what might be termed the unexpected expected expenses. Take car repairs. Do you know anyone who ever planned for a broken-down car? On the other hand, do you know anyone who has ever had a car that didn’t break down?

We want to be on top of our money, but instead we find ourselves avoiding thinking about it. It’s natural, in a way. It can be difficult and the opposite of fun. But our avoidance prevents us from doing the most commonsense, basic thing we can do to take control of our financial life: Learn how to save.

WHY IT’S SO HARD TO SAVE—PART 1

Why do so many of us seem to come up short when playing the financial long game?

Well, take a breath. We’re here to tell you that—wait for it . . .

It’s not totally your fault.

If you find yourself working long hours, not spending extravagantly, and still wondering why you’re not saving a dime, you’re not alone. There are lots of things out there that make it hard for all of us to save.

In her book Pound Foolish, Helaine told the story of how many of our financial lives collapsed. The most important takeaway: For all too many of us, wages began to stagnate and fall. Accounting for inflation, the annual median income of American households declined by about $3,000 between 1998 and 2013. At the same time, income inequality has increased. Almost all gains in household income and wealth in the past several years have gone to the top 1 percent of the population, even the top 0.1 percent.

But just because our salaries were all but frozen didn’t mean our cost of living enjoyed a similar break. Not only did the cost of all those things you can’t live without—think health care, housing, and education—go up, but they have generally gone up faster than our salary increases and the costs of less essential items.

And even as we faced all these hurdles, we don’t exactly live in a society that encourages moderation. In America, most of us idealize living large. Luxury is marketed at us incessantly. It’s easy to tell people—not to mention ourselves—to ignore the millions of social cues that encourage us to overspend. It’s certainly good advice but hard for all too many of us to heed.

When Helaine’s older son was born in 1999, you would have been hard-pressed to spend more than $400 for a stroller, and that would have been a bulky, less-than-practical European import. Yet by the time her younger son was born in 2003, the $1,000 Bugaboo was (for a surprising number of us) suddenly a must-have. A $400 stroller seemed like a bargain-basement item. It was a great feat of marketing.

Watch any play-off game. Halftime ads feature a parade of amazing cars. Reprising his look from The Matrix, Laurence Fishburne hawks the new Kia K900 (manufacturer’s suggested retail price $59,500). He intones that viewers should “challenge the luxury you know.” He wants them to think about “the way it makes you feel.”

All this seems counterintuitive given our tough economic times. How could we become more addicted to luxury spending? Yet research says it’s just what we should expect to happen. According to economists Marianne Bertrand and Adair Morse, authors of a paper called “Consumption Contagion,” the more the wealthier people at the top of the income ladder spend on high-status luxury goods, the greater the pressure to keep up across the income spectrum. This “trickle-down consumption,” as they call it, reduces the savings rates for all too many of us.

The result?

That’s the world we live in. It isn’t easy to step out.

WHY IT’S SO HARD TO SAVE—PART 2

The harder it is to make it through to the next day financially—whatever the reason—the harder you will find it to make careful and disciplined decisions. That’s not because you are a bad person who wastes money and, thus, lands in financial hot water time and time again. It has to do with how we human beings are hardwired, the way we react to scarcity.

Imagine that your car payment is due. Your daughter comes home from school with a notice that you forgot to send in $25 for an upcoming field trip. The same day, you discover your mom needs help paying for her latest blood pressure medication.

This comes a mere two months after you moved into a new home. It seemed like the right thing to do. It’s in a better school district. But the rent is higher, and that’s stretching you in ways you didn’t expect.

In all the confusion and panic, you forget the credit card payment is also due in two days. Suddenly you can add a $100 interest payment, not to mention the charge for late payment, to your financial woes.

Reading this, you are likely screaming, “No!” Don’t turn to that overdraft protection with the hefty fee! You don’t need another credit card! Just say no!

Someone—like you, for instance—intensely worrying about finances, however, is unlikely to think in that moment about the consequences of borrowing money. And it’s not because you are uniquely financially irresponsible. The fact is if you’re always worrying about your immediate cash flow, how to make it to next week or the next pay period, you are very likely to make mistakes.

When we want to build up body muscle strength, we slowly up our exercise routine. Jog a mile every day, and soon you’ll find yourself able to jog a mile and a half. You’ve built up endurance.

According to Sendhil Mullainathan and Eldar Shafir, the authors of Scarcity: Why Having Too Little Means So Much, constantly scrambling to address money problems doesn’t strengthen our money muscles. Indeed it has the opposite result. The more little decisions you need to make, the less likely you will be able to get the big ones right. Our money muscle doesn’t strengthen. It weakens from stress and overuse.

Mullainathan—who happens to be an academic coauthor of Harold’s—and Shafir call our self-defeating behavior “tunneling.” And financial tunneling happens to all too many of us. So, no surprise, we all too often turn to credit to get by, whether for emergencies or that dinner out with friends at the hot new restaurant. As the commercial goes, “There are some things money can’t buy. For everything else there’s MasterCard.”

So now you are thinking, “Tell me again, how is all this supposed to make me feel better?” How is anything short of bare-bones financial survival even possible?

The answer, and repeat once more with feeling, is Learn. How. To. Save.

Without learning how to save, you won’t be able to invest or pay down debt effectively. This is true no matter what your financial position.

How much should we save? you ask. Well, the title of this chapter pretty much says it: Ten to 20 percent of your gross income, the amount listed on your paycheck before taxes and everything else are taken out.

If you’re already saving more, then kudos and feel free to move on to the next chapter. But for most of us, our progress is best measured out one small step at a time.

Just think about this: If you can put aside 10 percent of each paycheck, you will have more than one month’s salary set aside in your first year! As an added bonus, you’ll experience a whole lot less financial stress and drama along the way.

CREATE A FLEXIBLE AND REALISTIC SPENDING AND SAVINGS PLAN

You can’t begin to save until you educate yourself about where and how you are spending your money. Chances are you don’t know. According to a 2013 survey by the pollster Gallup, two-thirds of us do not keep even the most rudimentary of budgets. That was certainly Harold’s reality.

You need to determine what day-to-day spending is necessary and unavoidable, what is a luxury but helps you get through the day, and, finally, what is excess. Only then can you avoid falling prey to spending traps.

This allows you to make trade-offs: I’ll take advantage of the office coffee machine, but I’ll use the money I saved to travel to Italy next summer to attend my best friend’s wedding. I’ll drop my landline phone to pay for my gym membership or boost my child’s college savings.

So how do you do this?

You can’t do this by simply looking at your monthly bills. You need to look at everything. That’s your day-to-day spending as well as your regular expenses.

Step 1: Monitor Your Spending

For three months, keep track of everything you spend money on, no matter how small. That $1.50 bag of Cape Cod Waffle Cut Sea Salt potato chips? It counts, just as much as your four-figure mortgage or health insurance payment.

It sounds like a time-consuming project, but it’s not. websites, programs, or apps like Mint.com and Quicken .com will automatically collect and categorize every credit or debit card transaction. You can even snap pictures of your receipts with your smartphone. All you need to do at the beginning is sign on every couple of days to make sure they are assigning things to the proper categories, not to mention input cash spending. (If you wait more than a week, you will begin to forget what’s what.)

You can’t know what you are spending until you actually see the dollars and cents laid out right in front of you. Dividing every expense into categories like “Children’s school expenses” and “Groceries” allows you to see the big picture. Otherwise, you don’t know where your money is going.

Step 2: Confront Your Spending

At the end of the first month, look over your categories, and see how much you are spending in each. The first month will give you a sense of your recurring, nonnegotiable, nondiscretionary expenses: rent or mortgage, health insurance, car payments, gas, child care, and so on.

Step 3: Refine Your Expenses over Time

If you monitor only one month of spending, you won’t gain a full picture of where your money goes. Routine but sporadic expenses such as car repairs, doctor bills, and the emergency trip to the cat’s vet are more likely to occur over a several-month period.

Over the period of three months, you’ll get a good sense of your other expenses: pet care, entertainment, dining out, and the other things conveniently charged on your credit card at random intervals.

Step 4: Create a Plan

A realistic spending and savings plan accounts for how much you earn and how much you wish to spend, and it leaves room for flexibility: Money for dining out, say, can be repurposed if you spend a bit more on computer equipment one month than you had otherwise accounted for.

While many people call this budgeting, it’s more helpful to think of it as surfing a financial wave. A budget sounds fixed. But while certain expenses can be planned and occur as regularly as waves—think of your rent or mortgage, for example—others cannot. As a result, the size and shape of this financial wave changes somewhat from month to month. One way to handle this? Know your regular and large expenses, monitor your other spending, and adjust as needed.

Step 5: Make Sure to Leave Room for Fun

See a movie, attend a concert, eat dinner out with a loved one a few times a month. Remember, starvation budgets work no better than starvation diets.

YOUR FIRST PRIORITY: SET MONEY ASIDE FOR AN EMERGENCY!

Think of saving as building a house. No matter how grandiose the house design, it won’t stay up for long without a firm foundation, one without cracks that can withstand the elements.

Your budget’s equivalent of a foundation is an emergency savings fund. This is the money you put aside for when things go wrong, and things go wrong for all of us.

An emergency fund brings stability and calm to your financial life. Instead of panicking at every little unexpected expense or needing to take money away from other wants and needs, you’ll have a small pot of money at hand, ready for use.

What constitutes an emergency? An emergency is an expense that is both immediate and absolutely necessary. It almost certainly implies something bad has happened. An emergency is . . .

To build your emergency fund, start stashing away three months of living expenses in an accessible savings account.

When we say three months of expenses, we don’t mean three months of your take-home pay. We mean three months of your nonnegotiable living expenses, things like mortgage payments and grocery bills. This will give you breathing room if you suddenly lose a job while also offering a source of cash for the unexpected doctor bill.

DON’T SWEAT THE SMALL STUFF

As you begin to prioritize savings, you will almost certainly discover budgeting’s cruel calculus. Unless you are a crazed shopaholic with the discipline of a dog eyeing a rare sirloin, count on your nondiscretionary expenses such as housing, transportation, and health care as being your largest outlays. They are also the ones offering the least flexibility—at least in the short run.

The experts say we should not spend more than 50 to 60 percent of our take-home pay on such expenses. Yet even if you realize you are spending $200 a month too much on rent and decide to find a cheaper place to live, you’ll need to find the money to move—and even a short move to a nearby neighborhood can wipe out more than a year of savings.

Helaine likes to call this the non-latte factor. You’ve all heard of the Latte Factor. That’s the term trademarked by the financial guru David Bach, who says if we just give up a $5 small luxury a day, we can retire millionaires. But if that were all it took, most of us would be millionaires already.

Helaine discovered the non-latte factor when she decided to cut a newspaper subscription bill, saving $40 a month. She was feeling great—until her health insurance company notified her that her premium would be raised by $100 a month the following year. The problem wasn’t the paper she enjoyed reading. Her financial issue was the much larger expense she had little control over.

Your biggest outlays—like your house, like your car—are your biggest problems. It’s important to get these right in the long run, but these expenses are harder to control in the immediate future. So what to do? There are no miracle cures here, no magic tips to make it all better. But there are commonsense stratagems you can use to get control of small expenses without feeling as if you were making huge sacrifices and give yourself some financial breathing room to deal with the big ones.

CASH IS KING

One way to cut back on spending is mind-numbingly simple but very hard to do in our society. Say good-bye to plastic and all virtual money. Studies have repeatedly demonstrated we will spend more—upward of 20 percent more—when we don’t have to handle physical, paper dollar bills.

That includes debit cards. According to a group of researchers led by Manoj Thomas, a professor of marketing at Cornell University, consumers will impulsively purchase more junk food at the supermarket when they use a credit or debit card over cash. No doubt the same is true when we wave a smartphone app like Apple Pay or rely on credit or debit cards we’ve saved and stored on websites. Why? Paper and metal money are real. They are not abstract. It’s painful to part with dollar bills one by one. Not so for the forms of money that don’t seem like money. It doesn’t feel like real money to us—until, that is, the bill comes due at the end of the month. Then it feels all too real.

When Helaine first began to write about personal finance, one standard tip given to people who thought they were overspending was to tell them to put their credit card in a glass of water and then place it in the freezer. If you wanted to buy something with it, you needed to defrost the water. The delay, conventional wisdom said, stopped a lot of casual spending. It’s likely that’s true. Listen to the entrepreneur Terri Trespicio, who went all cash for several weeks and then wrote about it:

I remember standing over a $3.89 container of dried cranberries, debating whether I’d get more satisfaction from gnawing on the fruit or from having that $4 in my pocket. (Ultimately, I chose the cash.) I made dinner at home instead of picking up takeout. When I did go out, I often decided to forego [sic] a second glass of wine and skipped entrees in favor of bar snacks or appetizers—decisions that were probably as good for my waistline as my wallet.

STARTS WITH AN A: SET UP AN AUTOMATIC SAVINGS PLAN

So how do you pry that money out of your wallet and get it to start working for you, not against you?

Make it automatic.

When savings is automatic, the money goes into some sort of separate account without your having to make it happen every month and without its passing through your own fingers with all the accompanying temptations.

For now, we don’t need to think about where to invest the money. We’ll show in later chapters that this question is easier than you might think. We also don’t need to think about whether we can afford to save, because . . . well, there is always something.

If you work at a traditional job, when you sign up for direct deposit, there is often an option for targeting some of those funds for savings. Use it. If you are freelance like Helaine, money comes in more erratically, and it is hard to set a monthly target. So what does Helaine do? All incoming funds are deposited to her savings account. She then grants herself a monthly “salary.”

A motivational tip: Many banks, credit unions, and brokerages allow their customers to set up what we call sub-accounts. Those are accounts that operate under the rubric of your main account but sometimes (not always) have a different account number. This is a good one for people putting money aside for multiple goals, whether emergencies or winter getaways to the Caribbean. If you need some added incentive, consider giving your accounts names so the money doesn’t feel so abstract. A few years ago, ING Direct (now Capital One) told the New York Times that the most common nicknames for their sub-savings accounts were the following:

1. Savings

2. Vacation

3. Emergency fund/rainy day

4. House

5. Taxes

DON’T PRIORITIZE EMERGENCY SAVINGS OVER CREDIT CARD DEBT

Meet Harold’s friend Betty. She recently confided in Harold that she and her husband keep several thousand dollars in a checking account, even as they maintain several thousand dollars in credit card debt. “I like having that money there in case my furnace bursts.”

Betty’s not alone. Many other people do similar mental accounting. We all know where Betty’s coming from. Having $4,000 cash money in the bank and owing $4,000 to Visa make many of us feel much more financially secure than having less money in the bank—and owing less money to Visa.

From a mathematical perspective, this makes no sense. Betty has spent thousands of dollars on unnecessary interest payments and related charges. Her furnace has never burst. Had she paid off that credit card bill, it’s likely she would now have the money available to fix that furnace if it did need repair. Why? Because the thousands of dollars she’s paid in interest payments could be resting comfortably in an emergency savings account. We’re not suggesting you completely forgo an emergency savings account in favor of paying down debt. We just want you to maintain a healthy balance between the two if you find yourself in this position.

BEGIN THE FINANCIAL LIFTING WITH ONE-POUND WEIGHTS

It’s quite possible that if you weren’t saving the proverbial blessed penny when you began this book, you will not be able to suddenly go from saving zero to saving 10 to 20 percent. Maybe you don’t have the money to do that, at least right now. Maybe your debt payments are too large. Maybe you simply lack the practice.

Or maybe you do it for a few weeks and boom! You can’t resist a new case for the iPhone. Don’t beat yourself up. Sudden deprivation—which is what committed saving can feel like—rarely works. No one is perfect trying to lose weight. No one is perfect on a financial budget either. The important thing is to keep at it and to make steady progress without going crazy.

Saving 10 to 20 percent is the ultimate goal, not something you need to achieve yesterday afternoon. We don’t want you to begin saving huge amounts of money, for instance, if you have any debts besides student loans and a mortgage. (Again, read the next chapter.) We want you to actually start today, do something, and keep it up so that you’re following a realistic plan. It’s better to save 1 percent consistently than try and fail over and over again to save 10 to 20 percent.

If you think you can’t save, or if your attempts don’t seem to be working, start small. Attempt to save 1 percent of your take-home pay. After a month, up this to 2 percent. After another month, make it 3 percent. And so on. By the end of the year, you should be saving close to 10 percent. The savings habit—unlike spending in a panic—is like a muscle. The more you use it, the stronger it will be. Think about it this way: No one expects you to start with a fifty-pound weight when you first go to the gym. That’s why the one-pound weight exists.