By Robert Stammers, CFA
Director, Investor Education
America Saves Week recommends that individuals find ways to “save automatically” as a means of achieving their financial goals without breaking the budget.
With America Saves Week (February 19–26) around the corner, it is a good time for Americans to review their savings habits and to determine easier ways to save. Many people have difficulty achieving their savings goals because they lack the financial discipline to save or because they set their savings targets well above what might be reasonable. One way to circumvent both of these issues is to find ways to save automatically that won’t have a significant effect on your budget but that can result in significant savings over time.
The Difficulty in Saving
To reduce the frustration that can occur when attempting to save, it is essential to set attainable goals, but it is even more important to develop financial management discipline. One reason the savings rate in the United States is low compared with that in other countries is that most Americans don’t know where their money goes.
Few prepare monthly budgets or know how much money they should have at the end of each month. The common practice is to get paid, spend on bills and other necessities, and then save as an afterthought.
With this type of unfocused financial management, anyone would be lucky to have any money left over. Even if you are fortunate to have some money at the end of the month, the overage is often put into temporary savings to cover any unexpected payments when the next month’s expenses come due. The adage “failing to plan is planning to fail” is apropos in this context because most people will find ways to consume their discretionary income if it is not already earmarked for saving.
Since many Americans do not have the required discipline to amass significant savings, this year’s America Saves Week encourages individuals to take action. According to Ken McDonnell, director of the American Savings Education Council (ASEC), “The theme of America Saves Week 2012 (set a goal, develop a plan, save automatically) is simple yet highly effective. Consider, according to the 2011 Retirement Confidence Survey, [that] workers who had done a retirement savings need calculation were more likely to be very confident they will achieve their goal (26 percent) as compared with those workers who did not (11 percent). ASEC encourages all Americans to take advantage of this opportunity to set a goal, develop a plan and save automatically.”
Setting an achievable goal is the first step in developing financial discipline. The next step is to create a plan that includes tactics for achieving those preset savings goals. As part of the plan, it is crucial that you find easy ways to save in order to increase the chance of success.
So, what does it mean to save automatically, and what resources are available to Americans who want to find easy ways to save? The key to automatic savings is to periodically and consistently move a portion of your income into savings in an amount that does not upset your overall budget. Although the amount saved may seem insignificant in each period, the fact that it is done continually throughout the year is what allows your savings account to grow considerably.
There are many automatic savings plans available, and they are perhaps best thought about in terms of the organizations that offer them. Generally speaking, the three easiest categories to use are those provided by an employer, those provided by a bank, and those “do-it-yourself” programs that require just a little bit of initiative. The following are just a few of the automatic savings programs that can lead to substantial savings over time:
The most popular and prevalent of all automatic savings programs is the employer-sponsored 401(k) that deducts automatic contributions from the employee’s paycheck. Many people find taking money from their paycheck an easyway to save because it forces them to live with less discretionary income and reduces the temptation to spend any money left over at the end of the month. Also, because the contributions are made pretax, many employees find that they can afford to save more.
Although they are not made available by all employers, a health savings account can be one of the best automatic savings plans available today. It is the only savings plan where money is not subject to taxation when contributed or when distributed. These plans are great for people who are saving for retirement and wish to have some additional resources to cover any unexpected or uninsured medical expenses. Once again, the contributions to HSAs are made pretax and taken from your paycheck before they are spent.
Most companies will allow their employees’ paychecks to be direct deposited into their bank accounts, but this does not mean that the entire check has to go into one account. Some people find it easy to save by having a portion of their paycheck deposited into a separate account or separate bank for savings purposes. Once again, having even a small, seemingly insignificant amount of money taken from your paycheck every period can result in sizable savings over time. Many people find that having their monthly savings taken care of before the bills come due also makes it easier for them to spend less.
Programs from Financial Institutions
Bank Savings Plan: Although banks are interested in helping their clients save, as a deposit institution they also benefit as their clients’ savings accounts grow. For this reason, most banks have several ways for their clients to save automatically. Two common programs are transferring a certain amount from checking to savings each month and rounding up expenses so clients can save the change. If you are interested in these types of automatic savings plans, you should talk to your banker about the different programs that are available.
Many online banks and credit unions offer their customers a nearly infinite range of ATM options by reimbursing all withdrawal fees at the end of the month. This presents a savings opportunity: If you withdraw cash normally but use ATMs that charge a small fee, you manage to “forget” about a chunk of money that will be rebated to you at month’s end. Some banks will even let you roll the ATM fee rebate directly into your savings account.
Dollar Cost Averaging:
Some individuals combine an automatic savings plan with an investment strategy. Many financial institutions and brokers can help investors dollar cost average, which entails buying a constant dollar amount of a security on a periodic basis. This strategy works well with buying into funds (mutual funds, bond funds, index funds, and ETFs, for example) as well as single-asset securities. This strategy reduces the risk of overpaying for a particular investment and can reduce the average cost of your investment over time.
Individuals can create a self-directed savings program that mimics what employers and financial institutions provide. For example, in the absence of a 401(k) plan, individuals can have their IRA contributions drafted from their bank account on a periodic basis to cover their annual contribution by April 15. Simply figure out the total contribution for the year, divide it by the number of periods to be drafted, and then have that amount drawn from the account periodically. This same process can be used to secure your children’s education by funding a custodial account for your children or a Section 529 college savings plan.
Keep the Change:
It is ironic that some people have their banks round up their expenses when it is just as easy for them to collect their change at the end of the day. Empty the coins out of your pockets as soon as you get home, find a safe place to keep them, and just let the pile grow. It is amazing how fast the day’s extra change adds up to real money. When the pile is large enough—a nice problem to have—you can take it to your bank and make a hefty deposit into your savings account.
Keep It Simple
With any of these automatic savings plans, it is paramount that the program be simple and easy to manage and that the deductions not have a significant impact on your ability to meet your financial requirements.
Remember not to get too aggressive in your savings. Saving automatically is not meant to be an austerity measure and shouldn’t be done in amounts that will keep you from covering the monthly expenses. Setting too aggressive a savings target often leads to frustration and excuses to stop saving. Also remember that it is never too late to start saving and that it doesn’t take that long to amass a pretty substantial nest egg. Looking at your empty bank account should not dishearten you or keep you from saving but, instead, motivate you to build the financial discipline to set a goal, make a plan, and start saving automatically.
America Saves Week (americasavesweek.org), is a campaign coordinated by America Saves (americasaves.org), a program of the Consumer Federation of America and the American Savings Educational Council (choosetosave.org) a program of the Employee Benefit Research Institute, two programs focused on promoting saving, debt reduction, and wealth building.
William Ortel contributed research and reporting.
The information contained in this article and from any related communication is for informational and educational purposes only. The information in this article should not be interpreted or used as investment advice. CFA Institute does not recommend or endorse any investment security, product, or strategy or any service, product, or material submitted by or linked to this article by third parties.