How To Budget & Save In Hard Times
Go to any mall and you can see merchants offering discounts, mark-downs and promotions to get those customers through the door. If the malls in my area are any measure, retailing strategies pay off with arena-like crowds and lots of big spending.
Given such enthusiastic consumption it seems almost unfair to mention the other side of the financial coin: Savings.
Figures from the St. Louis Federal Reserve show the savings rates have drifted down, “dropping from averages of around 9 percent in the 1980s, to approximately 5 percent in the 1990s, to almost zero in the first years of the new century. Recent reports in the media have alerted the public that the U.S. saving rate, as currently measured, is at its lowest level since 1933, the bleakest year of the Great
Depression. Of course, this historical comparison is disturbing at a minimum. Moreover, monthly data on household debt service payments as a percent of personal income have reached all time highs. (See: The Decline in the U.S. Personal Saving Rate: Is It Real and Is It a Puzzle? Federal Reserve Bank of St. Louis Review, November/December 2007)
Okay, so the numbers say we no longer save, at least in the sense of savings accounts. But is this really a problem? After all, many of us have seen a huge increase in real estate values over the past decade. If you think about it, that equity is a form of “savings” so despite recent pricing declines vast increases in home prices during the last few years have really amounted to a massive savings increase. And if we spend some of that accumulated equity, so what? Such spending is merely a by-product of the “wealth effect” created by growing home values.
For all the talk of the “wealth effect” created by rising home prices, real estate equity is only a potential cash equivalent. You can’t get at the wealth in your home unless you sell or refinance. If you sell you have to live somewhere else and your equity is reduced by selling and moving costs. If you refinance — perhaps by getting a home equity line of credit — some of your equity is effectively available to you, but only if a lender says okay.
In other words, home equity surely exists but it may be less than owners think and it may not be accessible without paying a lender. Or it may not be accessible at all with weak credit.
Savings — quickly available cash — is different. With savings, lenders pay you and your money is available on demand — even most certificates of deposit can be quickly redeemed, though owners will likely lose some interest.
With savings you don’t have to qualify to get your money. You don’t have to pay interest. You don’t have to make promises to a lender.
No less important, savings are available when needed. Think about the homeowner with an impressive level of equity — and think about that person after they’ve lost a job. Will lenders make loans to someone without income?
If savings are important then the question is: How much should you save and how should you save to get the best results?
It’s easy to say that savings as much as possible is the ideal formula, but that’s not quite the case. After all, there’s no sense working hard, earning a good income and then living like a hermit.
Instead, a more practical approach might be to set aside a certain amount of your paycheck or monthly income. Pick a number than makes sense, say 10 percent of your gross income — the money you earn before taxes.
If you have a gross income of $4,000 a month you would want to set aside $400. If $400 is impractical, try $300 or $200 or whatever number makes sense.
Take your monthly savings and divide it in two. Place half the money in a savings account and use the rest to reduce credit card balances and other debts.
Faster than you think you’ll pay off bills here and there. The money not spent for old bills, and the interest not paid, can then be added to savings and the same process can continue: half for savings and half for bill prepayments and reductions.
Imagine that you set aside $200 a month — $100 goes into savings and $100 goes to pay down the remainder of a dental bill. The bill has $1,700 remaining and you’re required to pay $50 a month. Increase that payment to $150 a month and the debt will be repaid in less than a year.
With the dental bill gone you now have an extra $150 a month — add that to the $200 you’ve been putting aside and you have $350 available per month. With such money savings deposits can increase to $175 a month plus $175 extra is available to tackle the next bill.
In addition, of course, there’s $1,200 in the savings. At the end of year #2 savings will have increased to $3,300 plus interest ($100 x 12 in year #1 =$1,200, $175 x 12 in year #2 = $2,100) plus an extra $2,100 will be available for debt reduction. Of course, if all debts are gone you can always put some or all of that $2,100 into savings.
With less debt credit scores will rise, meaning you will be able to borrow at lower cost. With lower monthly payments your ability to qualify for a mortgage or home equity loan will increase. With cash in the bank you will be better able to face surprise auto repairs or other emergency costs.
Is this the fast and slick way to earn money? Will there be a TV infomercial to sell this powerful, dynamic debt reduction program?
Not likely.
It will be hard at first, but with a little discipline it’s possible to radically change your financial profile regardless of your income. The way to start is to make a list of monthly bills, see which one you want to end first and then go for it.
With fewer bills and lower monthly costs the equity in your home will be cheaper and easier to get, a nice by-product of old-fashioned thrift.
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