I have my paycheck direct deposited into ING Direct. It comes in like clockwork on the first and third Friday of each month. Then, on the 10th and the 24th of each month, ING automatically transfers about 60% of that paycheck amount directly into my main checking account. I then proceed to live on what’s in my checking account.

Once every few months, I’ll go to ING Direct and do various things with the money. I usually transfer most of it into an investment account – the rest goes to replenish my emergency fund or help with some other short term savings goal.

This really works for me. I hope you share it with your readers.

I think this is a brilliant method for making automatic savings work. It strongly enforces the idea of “paying yourself first” – meaning that personal savings is the highest priority with your money. It forces you to learn how to budget with what you have – if you naturally live paycheck to paycheck, this really enforces some discipline on your financial life. You can throttle it back and forth however you wish – the less you automatically transfer from the savings, the more you will be able to save up for emergencies, debt repayment, and other savings goals.

If a person sticks with this plan over the long haul – no cheating and no dips into the emergency fund for non-emergencies – they can get ahead financially. The smaller the percentage of their paycheck that they transfer, the better off they’ll be.

An Example
Let’s say John brings home about $400 a week. He realizes that with some discipline, he can live just fine on about $300 a week – so he decides to try it out. He signs up for an online savings account, has his paycheck automatically deposited into that account, then sets up a weekly automatic transfer that triggers a few days later to transfer $300 into his main checking account.

John scrimps a little bit – taking on a few cash odd jobs, living lean – but he makes living on that $300 a week work. Halfway through the year, he gets a raise at work – now his paycheck is $425 a week, but he doesn’t change a thing about his savings plan.

At the end of the year, John has about $5,900 in savings. That’s enough to write a check for a fairly reliable car. That’s enough – with another two or three years of this – to have the down payment on a decent home. That’s enough to pay for some night classes or, in a few years, pay for a couple years of schooling leading to a bachelor’s degree.

For a person bringing home $400 a week, $5,900 can be “change your life” money. And all it takes is a year.

Switching to This System
This system isn’t too hard to set up, either. In fact, I use my own (overly complicated) version of this system to manage my own money.

First, start living leaner right now. You’re going to need to build up at least a little bit of buffer in your checking account, because there will be a period where you almost “skip” a paycheck. You’re not really skipping a paycheck, but this system means you’ll start receiving your paychecks about a week or so later than you used to. Thus, you will need some extra cash. Plus, you’ll need to live a bit leaner in order to survive on the smaller “paycheck” that you’ll get.

I usually recommend that people start by trimming some of the obvious fat, particularly through one-time actions. Look through all of your bills and see if there’s anything you can cut – premium cable, excessive cell phone plans, and so on. Work on improving the energy efficiency of your home.

Once that’s done, look at your regular expenditures. What things are you constantly spending money on? Breaking an expensive habit can be invaluable, as can moving away from eating out and preparing food at home instead.

Most people can trim a surprising amount of fat just by doing those two things. The problem is that many people then replace that trimmed fat with other unnecessary spending – but you’re not going to fall into that trap.

Once you’ve built up a little bit of a buffer, it’s time to set up your plan.

Sign up for an online savings account. I use ING Direct and I’m very happy with them, but there are a lot of options out there. An online savings account has the advantage that you can easily manage it at your own computer and also that it earns a solid interest rate.

The real advantage, though, is that it creates a wall between your savings and your spending. With an account at a bank completely separate from your primary bank, you can’t just stroll in and make a big withdrawal on a whim. Instead, you have to log onto your account, execute a transfer, then wait a few days for that transfer to clear both banks. That waiting period gives you time to really think through your decision and it will often convince people that they shouldn’t go through with an unnecessary expenditure.

Once you’ve done that, change your direct deposit at your employer to your new bank. It’s during this period that you’ll have to live lean and pay careful attention to the process, because the direct deposit may not necessarily arrive at your new bank at the exact same schedule as your old bank. Watch your new account carefully to see when the deposit comes in.

Once your first paycheck is in the new account, set up your automatic transfer from the new account to your old checking account. You have a lot of options as to how to set this up.

For one, you can match your current payment schedule – only a few days later – and simply transfer a bit less than you bring in. So, if you have a paycheck that comes in every week for $400 on Fridays, you can have a transfer the following Tuesday or Wednesday for $350 to your checking account. This will leave behind $50 each week in your account, which will really build up.

For another, you can slowly spread out your paychecks. For example, if you’re paid every two weeks (26 times a year), you can have the transfer happen on the 1st and 15th of each month for the amount of your paycheck – $400 – which would be 24 times a year. This would leave behind the two “extra” checks you get each year – a total of $800.

Or you can do both. If you have a weekly paycheck that’s $400 (52 checks a year), set up four transfers a month at $350 (48 transfers a year). This leaves behind $50 each time you make a transfer – a total of $2,400 over a year – plus the extra four checks – $1,600 a year – for a total savings of $4,000 over the year.

The key is to make sure that you’re transferring less than you bring in. How exactly you do that is up to you, but the purpose of this is to make sure you’re leaving behind some savings in the account. If $10 comes in, less than $10 should be going out.

Once the first transfer comes through from your new account to your old account, you’re good to go. The system is in place – you can largely forget about it. I recommend not changing anything if you get a raise – let that raise go entirely into savings. Instead, only make a change if you’re sure it needs to happen in your life. If you find yourself actually spending substantially less than you’re getting into your checking, lower that transfer a bit. If you’re struggling to make ends meet and you’re not wasting money, don’t be afraid to bump it up a little.

Good luck! This is a great plan that can really help kick your savings into gear.

Anyway, on page 82, I found a really interesting article entitled “Smooth Operators,” which discusses some very savvy saving techniques that have developed in nations with developing economies. First, though, is a bit on why such techniques are needed there:

Paying interest on your savings will strike most people as odd. Yet some poor people in the developing world do just that. In West Africa, for example, some people pay roving susu collectors a fee amounting to a -40% annual interest rate for looking after their deposits. [...] a similar phenomenon in India, where a female deposit collector named Jyothi looks after small savings for people in the slums of Vijayawada at an effective yearly interest rate of -30%.

To us, this seems very alien. Why would you bother to put money in a savings vehicle if you’re charged such outrageous fees?

To put it simply, money security is the real reason. Keeping significant amounts of cash on hand can be dangerous, and after doing a risk assessment, it’s pretty clear that to many of these people, it’s better to pay that painful fee than risk the high likelihood of having the money taken in some method – a -100% interest rate is far worse than a -40% interest rate.

But why save at all?

Many of the subjects emphasized [that] controlling the flow of cash becomes all the more critical when income is not just low, but also unpredictable and irregular.

In other words, many of the people using these savings systems have very irregular incomes, so in order to survive during the many lean times, they need to sock money away. And without personal security, they need a service that keeps the money safe, so they utilize the susu (and other local variants).

It’s not that different than the problems that people face in America, where many people have irregular incomes (I myself am one of them). To put it simply, if your income is irregular, you have to save. You can’t spend what you earn, or else you’ll be in deep trouble during the lean times.

What gets interesting, though, is some of the tactics the savers use.

They are acutely aware, for example, of the importance of some psychological phenomena whose effects behavioural economists have only recently begun to explore. For instance, they purposefully seek out commitments to help ensure that they meet their savings goals. Many of the South African women in the study joined several monthly “savings clubs” in spite of having bank accounts. They found that the extra discipline the clubs provided was valuable in itself, because it compelled them to save no matter what.

This is a really important point, one I think is overlooked in western society. Peer pressure is a huge motivator, and using it for savings goals pushes you strongly towards saving. The idea of a “savings club” seems a bit strange, but why not? Investing clubs are quite prevalent in the United States, and they have roughly the same goal – encouraging people to invest and keeping their eyes on the prize.

If you have some friends that are also trying to save for different goals, why not start a savings club? Meet once a month or so to talk about money saving tactics and to share your progress. Knowing that you have to tell the others in the club about your progress will push you to meet the goals you’ve set, lest you look bad in their eyes.

Another solid tactic comes later in the article:

The mother of a Bangladeshi man who found himself unable to stick to his monthly saving goal found she could make him save more by taking out a loan from a microfinance company. The shared obligation of having to pay the regular loan installments meant he abandoned his spendthrift ways.

At first, this might not seem like the best idea. Taking on debt to force yourself into regular savings behaviors?

But think of it from their perspective. That microloan might have a 10% interest rate. On the other hand, the susu down the street charges you 40% interest on your savings. Seems like a good deal to me.

This is not altogether different than when people play games with 0% balance transfers on credit cards. They write a cash advance check from card A into their savings account, then do a 0% balance transfer from card B to card A to cover that check. Then they hold the cash in their savings, earning 2-3%, until they have to pay back the 0% transfer. Along the way, they can usually earn a few bucks, particularly if the amount isn’t large enough to really harm their credit.

In both cases, it’s a crafty way to use the financial tools available to you in an unexpected way to put yourself in a better financial place. Don’t just think of a credit card as a way to buy more stuff. Don’t think of a low interest or a zero interest loan as bad simply because it’s debt. Instead, look at all the tools available to you – and use them together to maximize your situation.

Personal finance lessons can come from anywhere. Always keep your eyes open.

Of course, this article was written against the backdrop of the economic conditions of the time. We were at the peak of six years of economic growth, with only the faintest hints of the economic onslaught about to occur. We, as Americans, also had a negative savings rate at the time – we were actually spending more than we earned as a whole (which meant that there were a whole lot of individuals spending far more than they earned).

Today, we live in a different world. Saving has certainly rebounded – many estimates show that the savings rate is now somewhere around 5%. The economy has certainly slowed as well, and countless trillions have been lost in a 50% dip in the stock market.

So, now’s the time to revisit that question: is saving money instead of actively spending it bad for the economy? Again, I come to the same conclusion – no – but this time, there’s a bit more food for thought on the vine.

The Paradox of Thrift
The whole idea that saving money is bad for the economy comes from the economist John Maynard Keynes, who referred to it as the “paradox of thrift.” (”Paradox of thrift” and John Maynard Keynes is one of those things you can bust out at a party to seem quite smart.) He believed that if everyone saved more money during times of recession, then demand for goods will fall. If demand for goods falls, then economic growth will stall, causing all sorts of additional economic problems (lost jobs, failed businesses, etc.).

It makes some sense on the surface. If everyone stopped spending money tomorrow, the economy would indeed fall apart. There are two big factors that keep this from happening.

First, when demand falls, prices fall, and when prices fall, people are more likely to spend money. That’s why sales always work – and thus businesses regularly have sales. If demand falls across the board, then businesses will lower their prices to get more customers.

Savings Accounts Contribute to the Economy
The second factor – and this is the big one – that makes the “paradox of thrift” fail is that putting money in savings accounts does not remove it from the economy. When you put money in a savings account, it becomes money that the bank can then lend out to businesses. Thus, when more people save, the banks have more resources to pump out to businesses, and when the businesses have more resources, they employ more people, innovate new products, and find new ways to sell.

This is a simple example of why the economy cycles back and forth between economic growth and recession. Right now, we’re in a recession and we’re putting our money away in various savings accounts and investments. That money is then being loaned out to businesses of all kinds who are taking advantage of the very low interest rates available. This means that businesses will soon begin hiring people – reducing unemployment and getting more money out there in the hands of consumers. With more people involved in steady work, more money will be spent and the economy begins to grow. Eventually, people stop saving as much – times are good. The banks then slowly close the taps since they don’t have as many resources for lending. Businesses feel the pinch and begin laying off workers – and we’re back to a recession again.

By saving, you’re actually doing your economic duty, just as you would be if you were buying things. A healthy economy needs plenty of both.

Hoarding Doesn’t Help the Economy
This, obviously, doesn’t include the guy with hundreds of dollars in his mattress or in his safe, or the guy who buys gold coins and buries them in his back yard. That type of saving (I view it as hoarding) does not help the economy at all, as it locks up money in a place where it’s not constantly being cycled back and forth between workers and employers, between businesses and customers.

If you’re concerned about whether or not saving money will help the economy, be aware that it will, but only if you actually invest it in a business (by buying stocks), in a community (by buying bonds), or in a bank where it can be distributed through business and personal loans. That way, you can not only build a safety net for yourself, but you can also do your part in making sure the economy functions like a well-oiled machine.

Quite often, though, I had the itch to find something better to do with the money. I eyed putting some of it in CDs (certificate of deposit, which basically means you give a certain amount of cash to a bank for a specified period of time – it earns a higher interest rate than a savings account, but you’re penalized most of that return if you cash it in early), but I didn’t want to lock up a huge amount of it for a long period of time. I wanted to always be able to have that cash when I needed it. After doing some investigation, I decided that a CD ladder was the right move for me.

What’s a CD Ladder?
Simply put, a CD ladder is a collection of CDs bought at regular intervals so that they’ll mature at regular intervals as well. Let’s say I wanted to create a simple CD ladder out of six month CDs. I buy one on the first of each month for six months. Then, on the first day of the seventh month, that first CD I bought matures and I collect a nice return. I can then either buy a new CD for the original amount and pocket the return, just keep all of the return and the original amount for some purchase, or I can buy a new CD for the total return. After that, each month, a CD matures and I can either buy a new one or use it for something else.

If you’re doing this with your emergency fund, you can set it up so that you always have a month’s worth of living expenses available in cash and each of the CDs represents a month’s worth of living expenses. Thus, each month, you’ll have a CD mature, collect a higher interest rate, and you can use the returns to buy another CD (if you don’t need it for an emergency), leaving you with a month’s worth of emergency fund at all times.

Why do this? Why not just keep all of it in cash? The biggest reason is that CDs often return a percent or two higher than your savings account. At ING Direct, for example, the CD rates range from 3.75% to 4.5%, while the savings rate is at 3%. Another reason is that by locking it into a CD, you’re not tempted to spend it.

How Are You Doing It?
I started my CD ladder in September by purchasing three $1,000 CDs out of my cash emergency fund. The total was a bit less than a month’s worth of living expenses. I bought a 6 month CD that returns 3.75%, a 12 month CD that returns 4%, and an 18 month CD that returns 4.5%.

So, in September, I held these CDs:
A $1,000 CD that matures in March 2009 at 3.75%
A $1,000 CD that matures in September 2009 at 4.00%
A $1,000 CD that matures in March 2010 at 4.50%

Notice that the shorter-term CDs don’t return quite as well. Specific rates vary all the time, but it’s a rather constant rule of thumb that longer term CDs return better than shorter term CDs. Thus, instead of just buying a single six month CD, I decided to spread things out to get a better return on at least some of the money.

During September, I kept building our emergency fund as I usually do, putting around 10% of our income into it (which is around 15-20% of our monthly living expenses). I’ll keep doing this for the time being.

At the start of October, I bought three $1,000 CDs again out of the cash emergency fund. This left me with six CDs:
A $1,000 CD that matures in March 2009 at 3.75%
A $1,000 CD that matures in April 2009 at 3.75%
A $1,000 CD that matures in September 2009 at 4.00%
A $1,000 CD that matures in October 2009 at 4.25%
A $1,000 CD that matures in March 2010 at 4.50%
A $1,000 CD that matures in April 2010 at 4.25%

You can probably see where this is going. According to my calculations, we’ll have about four months’ worth of cash living expenses in our emergency fund in February 2009 after buying the CDs each month (remember, I’m still adding cash to my emergency fund). Each month after that, a $1,000 CD matures. I’ll then buy a single 18 month CD for $3,000, which would be enough to sustain my family for a month. And I’ll repeat that for eighteen months.

In August 2010, I’ll own eighteen 18 month CDs which will mature in one month intervals, just like clockwork. If I have my calculations correct, we should still have roughly a month’s worth of cash emergency fund at that point. So, I’ll basically have 19 months worth of emergency fund, almost all of it returning 4.25-4.5% or so.

Here’s what things will look like at that point. I’ll have a savings account with one month worth of living funds in it. Each month, an 18 month CD will mature and the proceeds will go into that account – both the principal and the interest on that CD. At the start of the next month, I’ll buy another 18 month CD worth roughly a month’s worth of living expenses. And as long as we’re able to get by just fine on our normal income, I’ll keep this cycle going, as it’ll serve as a huge emergency fund that also returns at a pretty solid rate.

Why not invest it? This is the typical question I hear about cash emergency funds. Usually, such questions are implying that I should put that cash into the stock market and maybe earn a bigger return. I view this as an investment. Since I’m not saving this money for the long term – it’s a cash emergency fund, after all – I want it to be safe, secure, and stable. It needs to be there for me if I need it.

Another reason for doing things this way Following this plan enables something else interesting as well. When this is actually set up and working, it would enable either me or my wife, without skipping a beat, to go back to school. In truth, my wife is considering the move – she’s looking at perhaps going back to school for a master’s degree in 2010 or 2011. Putting this in place makes such a move quite possible.

If you have a big emergency fund that you won’t need all at once, consider starting a CD ladder with the money. Even a six month CD ladder can create a nice bump in your interest on your emergency fund without adding any risk.

On an individual basis, the messages are innocuous. For example, one recent email was for Heroes: Season 1 on DVD for $29.95, a pretty strong price. Given the people on the list, of which a large number are lifelong comic book fans, this seems like a worthwhile thing to mention since many of them are either fans of Heroes or are potential fans of the show. If you make a splurge purchase like this once a month, it’s not that big of a deal, and it’s something that many people on that list might enjoy.

The problem comes in when you read ten or more of these messages a day. The Watchmen for $8.99! Guitar Hero: Aerosmith for $19.99! A 50″ LED TV for $799! People were even linking to cheap eBay auctions.

It culminated (for me) with a recent email to the list (emphasis added):

Thanks for the emails guys! I saved so much money this week!

I realized, right then, that this had turned into a “deals” list, so I unsubscribed.

What’s Wrong With Finding Bargains?
A lot of people might read through those prices and think, “Wow! Nice deals!” For the most part, they are solid discounts on what you’d normally pay, and if you were already thinking of buying one of those items, it’s probably not a bad time to go ahead and pull the trigger.

The key part, though, is “if you were already thinking of buying one of those items.” When you go “bargain hunting,” you’re not seeking out a particular item that you need. You’re simply seeking out low prices and accumulating stuff for the sake of accumulating stuff. And, even though an individual item might be a bargain, buying a bunch of items is a sure way to empty out your pocketbook and make it difficult to make ends meet.

Doing that leaves you with a house full of stuff you didn’t really want and a nice big fat credit card bill.

Sensible Bargain Hunting
That’s not to say there isn’t a role for bargain hunting – there is. But when people snap to attention and pull out the wallet when they hear the word “sale” or see a big discount, they’re going at it completely in reverse.

The sensible way to bargain-hunt is to know exactly what you want before you even start looking. If you’ve decided, on your own, that you do in fact want Heroes: Season 1 for your own entertainment, great.

Now’s the time to bargain hunt, with the item you already have in mind. Utilize tools for finding it, like this clever trick for automatically bargain-hunting Amazon for specific items. Use price comparison tools to find the item at a steep discount. Set up saved searches on eBay and check them regularly. Check out retailers and see what their offerings are like.

The important part is to put on your blinders and ignore other items. A big sale on an item you don’t really want is still a waste of money.

Purposeful Bargain Hunting for Profit
One of my online acquaintances – a person I’ve mentioned a few times recently – makes his living selling trading cards online. He actually does very well at this. But he also bargain hunts quite often without any specific item in mind.

See, he happens to be a walking encyclopedia of trading card prices, and he’ll often go to different places simply canvassing for bargains. He has nothing in particular that he wants to buy, but there’s a chance he’ll stumble upon something that is genuinely mispriced. If he finds it, he’ll actually clean the store out of the item. He’s put more than $2,000 worth of trading cards on his credit card in one swoop when he didn’t intend to buy a single thing.

The difference here is that he’s not buying “stuff” to accumulate for personal use. He’s bargain hunting without anything specific in mind, sure, but when he’s buying the trading cards, he’s not actually buying trading cards. He’s buying goods to profit from – and he will profit from them.

In other words, using “well, I’ll make a profit” as a bargain hunting excuse only really means anything if you’re actually doing it. If you see an item you don’t need and didn’t really want, but you buy it because you think it’s actually worth more than the price, you’re still wasting money. The only way it’s actually worth more than the price is if you can actually sell it at a higher price.

Most Bargains Aren’t Bargains
The simple truth is this: if you’re buying something you don’t really need and didn’t really want before you saw it, you’re wasting your money (unless, as I mentioned, you’re going to directly profit from it). It doesn’t matter how good the “deal” is – if it’s something you weren’t planning to buy anyway, you’re just throwing away your money for stuff, and that’s a sure way to put yourself in a worse financial position.

By all means, buy some fun stuff for yourself. Just spend some time thinking about what you actually want – and then hunt for bargains on that item.

Several months ago, I went out to lunch with a couple people who wanted to tell me about a project that they were working on that they thought I might be interested in. They knew of me via The Simple Dollar and, because they were based in Des Moines and I happen to live near Des Moines, they thought it was a great opportunity to get my opinions and thoughts.

Since the lunch was free and I had the afternoon off anyway, I thought, “Why not?” The worst that could happen is that I get a free lunch and listen to some boring conversation. I had heard a few pitches like this before from various people and groups and most of the time I saw very little that would get me excited.

That group was the SmartyPig team, and the set of ideas they’ve come up with is genius.

What’s SmartyPig?
Right now, I use ING Direct as my primary bank. They provide my checking services, my savings services, and all of my online bill pay services. They even allow me to set up sub-accounts so that I can save for specific goals. In my opinion, ING Direct is the best of the full-service online banks, and I’m a happy customer of theirs.

Still, when I look at online services like mint.com, I’m jealous: the idea of sharing saving goals with others is very intriguing. Personal finance and saving money has the potential to be as social as any other activity – we can involve our friends and family in the process and make it a point of conversation and a point of pride.

I can’t help but think back to when I was a teenager and saving for a car. My family was intimately involved in this process, and they encouraged me all the time to keep saving. My dad would occasionally put a few dollars into the account, and my mom would sometimes slip me $5 towards the car when I would take out the trash. Other family members, particularly my grandmother, were quite encouraging as well, and even a few of my friends were in on the story. When I finally got the car (and got it fixed up and road-worthy), it felt like not only a goal I had achieved personally, but a goal I had shared with my family, too – they were happy for me as well as they had seen the progress all the way along.

I’ve often thought that this type of thing would be a very cool feature for an online bank. Why not allow people to set up “public” savings accounts for such goals and then allow others to contribute money to that account and watch the progress? When we were buying a crib for my son, for example, both grandparents wanted to contribute and wanted to know how we were doing in saving for that crib (we were getting a gorgeous one that would be perfect not just for our children, but for their children and so on). One of them even suggested that we have a baby shower themed around the crib we had in mind, but there was no intuitive way to put the pieces together for it.

SmartyPig is basically the solution to this. SmartyPig is basically an online front end for West Bank, a bank chain here in Iowa. It basically allows you to set up savings accounts for specific goals and make these accounts “public” so that others can track the progress in the account. You go in, define a savings goal, set up an automatic savings plan that pulls from your checking account, and then watch your progress towards that goal. The account offers a pretty competitive interest rate, too. When you’ve reached a savings goal, SmartyPig issues you a MasterCard debit card that contains the full balance of your account, and you take it to wherever you want to go to spend it.

SmartyPig took the next logical step, too. They hooked in a number of retailers to kick it up a bit more. Let’s say, for example, you’re saving for a KitchenAid Pro stand mixer and you’re going to buy it off of Amazon when you reach your $300 target. If you specify that as your savings goal on SmartyPig, you’ll get the option of getting that $300 as an Amazon gift card – and they’ll kick on a few extra percent towards the purchase. So, for example, you might get an Amazon gift card at the end with a value of $315 or a MasterCard debit card with a value of $300 – your choice.

My Concerns
SmartyPig is a combination of two very good ideas – the social sharing of an online savings account, plus the option to roll it into a gift certificate for extra savings. I’m left with just a few minor concerns.

First, any time you sign up for another bank account, you’re giving your personal information to at least one more source. While the risk is slight, it does exist – there is no perfect security in the world and your best protection is to always minimize the number of places where your information exists. In a nutshell, I usually need a compelling reason to share my personal information – if it’s there, I’m okay with going forward, but I don’t hand out my information unless I can clearly state the reason and it’s a worthwhile one.

Second, the maximum benefit of SmartyPig comes from consumerism-oriented goals. While you can use it for things like a $5,000 emergency fund, SmartyPig doesn’t lend itself well to goals like that. By its very nature, SmartyPig is for saving for item-oriented goals. While this can be good – it’s a great way to save up for a new washer and dryer, for instance – it can also be bad if you use it to save for extra stuff you don’t really need.

Will I Use It?
For the exact purpose that it fills, SmartyPig is a wonderful online savings option, and I’m using it to save for at least one specific future purchase – a new dryer. Our old one is on the fritz, and this is a very subtle way to get the cash for a new one. My wife is considering adding a new washer to that goal as well. I have not yet shared any goals, mostly because I can’t think of a good idea for one to share.

I will admit to being tempted to set up a savings goal to save for a few frivolous things – and I think that’s one of the dangers of SmartyPig. It’s fun to play with, and my natural instincts are encouraging me to set up savings goals for things like a digital video camera setup.

Should You Use It?
SmartyPig excels at facilitating goal-oriented saving – if you’re saving up for a specific item, this is perhaps the best way I’ve ever seen to self-motivate to get it done and earn some solid returns in the process, both from the interest earned in the account and in the potential gift card you can get when you cash out. If that’s something you struggle with, SmartyPig is a very useful tool for taking that journey. The real question is whether you see a role in your life for such goal-oriented saving – not everyone does, and if it seems pointless and consumeristic to you (which has been the reaction of at least one person I’ve described SmartyPig to), then there’s no need to sign up for an account.

Personally, I think it’s a big help if you’re slowly socking away money for a specific large purchase, and it can be a compelling tool if you’re wanting to share a savings goal with others.

I looked at my options. My wife and I have been using the same cell phone provider for the last four years and have been very happy with them. We had heard rumors that their service in the area of our new home was bad, but the service has actually been even better since we moved – I haven’t seen anything less than four bars at home or in any place that I go to regularly. Thus, my wife and I wanted to stick with the same service provider.

I went to the cell phone store today with my tactics for buying a new cell phone in mind. I wanted to make a change to my service plan (upgrade my text messages and my minutes because I’ve gone over the top on both of these recently) plus get a new phone. I had decided that I wanted a RAZR because of the feature set that it had and the size of the phone itself, but I did not want to walk out of the store paying more than $100 for the phone, a car charger for the phone, and any other fees.

Here’s exactly what I did.

I walked into the store, briefly surveyed the people working there, and grabbed the one who was not involved with anyone at the moment. I told her that I was potentially interested in a new service plan (my old one had expired and I was just paying by the month) and specifically what I wanted with the plan. I also told her I wanted new equipment and walked away to look at it to let her think about it for a bit.

I knew better than to negotiate the service plan because it’s usually set by national carriers, but I knew that basically anything in the store was negotiable, especially fees. I also knew that I’d be able to get several things from this person, whose eyes were already calculating their sweet commission on the sale.

I went for a RAZR, just as I wanted. I asked for details on all available rebates and the person actually filled out the rebate form for me to get $30 back – literally, I’ll go home and drop the information in an envelope and send it.

There were also two different fees that the person attempted to ding me with. I directly asked for each fee to be waived and, although the lady helping me seemed a bit startled at the request, she said “Sure” and waived them without hesitation.

I also asked if there were any discounts on accessories for the phone and ended up with a 50% discount on the car charger.

The end result? I got my plan changed, a Motorola RAZR, and a car charger for less than $70 after I drop the rebate (already filled out) in the mail. Easy as pie.

Three real keys if you are getting a new cell phone: ask for all possible rebates, ask for fees to be waived, and ask for discounts or coupons on accessories. Remember, you’re the person in the store spending money – don’t feel bad about asking for such things.

I was intrigued by this, so I went home and did the math on it and a few other account ideas. If you put $5 away each week from your child’s birth to his 21st birthday into an HSBC account that earns 5.05% APY, your child would have $9,441.68 on their 21st birthday. If you put $10 away each week, the child would have $18,883.35. I also considered continuing until the child was 25 in order to spur on a down payment; if you did that at $10 a week, the account would have $25,185.81 in it.

Is the savings account too little? Each year, roll the account into an index fund. If it returns 8% a year (a low estimate), you’ll be doing even better ($10 a week until age 25 would yield $38,952.16). It’s rather clear that given the large period of time, you really give compound interest a chance to work.

Why do this? If I suddenly had $38,952.16 drop on my lap at age 25, I would have immediately had enough for a down payment on a home. We would not have spent years in a very tiny apartment – we could have moved on to a wonderful home earlier than we did. On the other hand, if I had that kind of money dropped on me before my financial meltdown, I’m not entirely sure I would have been mature enough to handle it. Ideally, I would think that I would have used it to pay off my debts, but I’m honestly not entirely sure about that.

Another aspect of the question is what financial support do you feel appropriate giving to your children? Once I turned eighteen, my parents gave me very little financial support – they assisted with textbooks the first semester or two, but after that, it was entirely up to me. I know other families, though, with children in their late twenties who still rely on their parents for many necessities of life. Doing this is in some ways actively choosing to not cut the cord.

When your child is born, one of the first questions you’ll ask yourself is how do I take care of this child over the long haul? A straightforward investment like a savings account might be an appropriate choice for you.

Step 1: Log in to your ING account Enter your information and go view your overall account information.

Step 2: In the upper left, click on the “Open Account” option You can see it clearly in the picture above.

Step 3: Choose to open a new savings account on the next screen The “Open Now” link in the image above is where you should go.

From there, the process is really straightforward – you can call each account you create whatever nickname you like to identify it as a distinct fund: an emergency fund, a “house maintenance fund,” a “vehicle replacement” fund, and so on. From there, you really should set up automatic deposits into each of these funds so that you can always be building up these funds.

Why not do this instead of using Excel? In fact, I did do this for quite a while. I moved my primary savings out of ING Direct not too long ago, not because of the service, but because having all my savings accounts so easily available made them tempting. (note: I later moved everything back to ING because of HSBC troubles). I moved the savings accounts to a single HSBC Direct account, and I manage the distinct layers in Excel. I’ve actually left all of my old accounts in place in ING and when I’m ready to get money from HSBC into a particular fund, I withdraw it from HSBC directly into the matching ING account, so I can quickly see when that money’s there and ready to go.

What’s a home maintenance fund? A home maintenance fund pays for the continual maintenance of things that we have right now. This includes things like pest spraying, weatherproofing the deck, having the chimney swept, replacing furnace and air filters, replace worn-out carpets, and so on.

How much will that cost? I’ve heard various recommendations, but we’ve settled on putting away 1% of the assessed value of the house and land annually into the account for home maintenance. This means that an amount equal to 1/12th of 1% will be pulled out of our primary checking each month into that account (for a $200,000 house, that means $166 a month), and then when home maintenance issues occur, we’re free to tap that fund to get the lawnmower fixed or replaced, to buy sealant, and so on.

OK, what’s a home improvement fund? Over time, we’re going to want to upgrade a few things around the house. We haven’t even moved in yet and my wife is talking about planting a small row of fruit trees along the farm-facing edge of our property, for example. Things like this are things that don’t currently exist but can improve the value of the property over time. We want to plant two apple trees and two cherry trees, and if we care for them properly and guide them to adulthood, they’ll increase the value of the home. Another topic we’ve talked about is installing quartz countertops in the kitchen.

We also want a home improvement fund so we can avoid home equity loans, a strategy I talked about last week.

How much will that cost? We estimate that improvements will likely be more expensive than maintenance, so we’re going to sock away 2% of the assessed value of the house and land annually into that same account for home improvements. This means an amount equal to 1/6th of 1% will be pulled out of our primary checking each month (for a $200,000 house, that means $333 a month). This is pretty high, we think, but it does enable us to start thinking and planning home improvement projects and knowing that we’ll be able to pay for them when we decide what to do.

It seems expensive now, but if we look at this as just another bill to pay, it will lead us to success in the long run.

See that little Snickers bar wrapper over there? It was my addiction. For years. I would eat one in the morning and one in the afternoon out of the vending machine at work. Seventy five cents a pop, making it cost a dollar fifty a day. Most days, this would literally just come out of pocket change, so it never really felt like a big expenditure, plus I was often quite happy to have that mid-morning and mid-afternoon energy rush that the bar would provide.

When I started Volumetrics, I started looking carefully at the nutrition labels on different items and the Snickers bar made me almost jump out of my skin. Wow! That candy bar alone was worse for me than almost any meal I would eat. I realized that for health reasons I needed to kick the habit, and I knew in the back of my head that it would help financially, too, but I was really worried about that mid-morning and mid-afternoon energy rush.

What did I do instead? Fruits, and a variety of them. I kept high-energy fruits on my desk: grapefruits, oranges, and bananas, mostly, picked up at the store for less than a quarter a pop. I’d eat one in the mid-morning and one in the mid-afternoon as an energy booster and it matched well with Volumetrics, too. I missed the Snicker’s bar, of course, but the routine of a banana in the morning and an orange or a grapefruit in the afternoon quickly replaced it – I didn’t even think about it any more after a couple of weeks.

I was spending a dollar less each weekday, so after five weeks I had lost a bit of weight, which was a nice reward itself. Not surprising to anyone, though, I decided to run the numbers to see how the saving was going. The math here is simple – five weeks of saving a dollar a day means $25 I didn’t have before. If I contributed that $5 a week to my daughter’s 529 account and it returned 10% a year, on her eighteenth birthday the account would have $12,200 in it.

$12,200 for college and a smaller stomach. I think my daughter would be proud of her dad.

To a degree, this even continued after my financial meltdown. I focused strongly on debt repayment at first, knocking out my credit card debts, but not really saving anything at all. I still hadn’t really grasped how to make it work for me.

It finally clicked one day when I overheard an elderly neighbor talking about paying her bills on her phone to her niece. She said that she had to write a check to the bank to put into savings, including it as part of her monthly bill routine. It seemed so simple and obvious, yet I had just completely overlooked it. Here’s what I did to get started.

First, I set up a savings account at a different bank than my primary checking account. At the time, I set up a savings account at ING Direct – it was easy to set up and had a good interest rate.

As soon as the account was ready to go, I immediately began to treat deposits there as another regular bill. I paid most of my bills online already with online bill pay, so I just added a regular contribution to the savings account to the pile of bills. I actually set it up so that I made a contribution this way and there were small additional contributions pulled out of my checking account on a weekly basis ($20 a pop).

Treating it as a bill and at least partially making it automatic made it much easier for me to start actually saving money. At that early stage, I didn’t worry about the idea of an emergency fund or a car fund – I just focused on the idea of building up cash in savings so that my future me would have something to fall back on.

As time went on and this became completely routine, I began to refine my strategy, but I still just treat contributions to savings accounts and investments as regular bills.

What’s the net effect? The biggest effect is that I’m not left with all that much money “floating” from paycheck to paycheck. Most of my money is used to pay a bill, whether it’s a “real” bill or just a savings or investment contribution. The second effect is that I know my savings and investments are growing and I know that if something happened now, I would have lots of cash tucked away. This literally makes me sleep better at night knowing things are secure.

If you’re having trouble saving, try setting up an account at a new bank and then putting in a contribution every time you pay the bills – treat thins contribution as another bill. Then, when you’re tempted to spend what’s left in your checking account, that cash won’t be there to tempt you to make bad decisions.

After analyzing our spending patterns over the past couple of years using our Microsoft Money data file, I determined that we needed to keep our committed expenses at or below 60% of our gross income to come out ahead at the end of the month.

Committed expenses:
* Basic food and clothing needs.
* Essential household expenses.
* Insurance premiums.
* Charitable contributions.
* All of our bills — even such non-essentials as our satellite TV service.
* ALL of our taxes.

I’m not saying that 60% is a magic number. It’s a workable goal for my family, and it’s a nice round number. But your number might well be a bit higher or lower. At any rate, it’s a good place to start.

Then I divided up the remaining 40% into four chunks of 10% each, listed here in order of priority:

Retirement savings: consisting entirely of my 401(k) contribution, which is subtracted automatically from my paycheck.

Long-term savings: also automatically deducted from my pay to buy Microsoft stock at a discount as part of an unusual stock-purchase program. The relative lack of liquidity (i.e. the difficulty of turning these shares into cash) makes it harder to spend this money without some planning and a series of deliberate steps. In a real emergency, though, I could sell and have the cash wired into my bank account within three days, so this is also our emergency fund.

Short-term savings for irregular expenses: which are direct-deposited from my paycheck into a credit union savings account. Money in this account can be easily transferred into our checking account, as needed, via the Web. Over the course of a year, I expect to use all of this money to pay for vacations, repairs, new appliances, holiday gifts and other irregular but more or less predictable expenses.

Fun money: which we can spend on anything we like during the month, so long as the total doesn’t exceed 10% of my income.

So, they spend 60% of their income each month on required expenses (food, house, taxes, etc.), sock 10% away into a 401(k), sock another 20% away into long term and short term savings, and spend the other 10% on fun stuff. This general framework became so popular that it has been incorporated into recent versions of Microsoft Money, making it easy for people to organize their finances using this model.

I basically feel that this is a fantastic framework for people who are trying to get their money straight but have no idea where to start. A few little caveats, though:

60% is a baseline, not a hard and fast rule. If you dive in, I suggest starting with 60% and seeing how it goes. If you actually find it easy, try some frugal things and see if you can turn it into the 50% solution (and kick that extra 10% into savings); if it’s extremely difficult, make it a 65% solution for a while.

Frugality helps. Being frugal cuts down on that 60%, making it easier for you to reach that target or, even better, enable you to beat it. Doing things like installing CFLs instead of incandescent bulbs and practicing good shopping habits simply shave money off of what you owe every single month, resulting in some serious breathing room.

The short term savings is basically an emergency fund. As I’ve mentioned before, an emergency fund is one of the best assets you can have because it can earn at a solid rate, plus protect you from going into debt when the inevitable happens. If you don’t have one and are thinking of diving into the 60% solution, I would redirect some of the long term savings into short term savings until you reach a pretty solid number for your emergency fund. Personally, I’m shooting for eighteen months’ worth of emergency fund as soon as I can manage it – a very large emergency fund is personally important to me.

Don’t beat yourself up if you try it and at first don’t succeed. This is true for any personal finance goal, because such goals are a lot like diets: people set very difficult goals right off the bat, fail to reach them, and thus use that as an excuse to fall back on bad habits.

Occupation My primary occupation and side businesses all place me in the upper middle class range.

Education I received a bachelor’s degree, which puts me in the “top fifth.”

Income I used our whole household income estimate for 2007, which includes my primary employment, my wife’s primary employment, and income from my side businesses and investments. This puts us just in the “top fifth.”

Wealth Because we’re just now digging out of some stupid financial decisions, we are decidedly in the middle class range for wealth.

Average Overall, this tool identifies my family as being “upper middle class,” even though our wealth is decidedly “middle class” at this point. I would conclude that our other socioeconomic factors (our job, our education, and our income) all indicate that our wealth should move into the upper middle class range as our life goes on and perhaps even into the “top fifth” range and thus the tool has a bit of an age bias (it’s hard for young people to have accumulated the wealth that is identified as “top fifth” unless your last name is Rockefeller or something).

What else can we learn from this tool?

Education is a major key to upward mobility Assuming that education plays a significant role in class mobility as indicated in this article, the best way you can position yourself to move up in class is by working hard and getting an education. Completing a bachelor’s degree puts you in the top fifth in education simply because only 9% of Americans actually manage to acquire one. So, get an education.

Jobs that require you to use your mind generally have more prestige than manual labor jobs This isn’t surprising, but intellectually challenging jobs populate the upper third of the job prestige list, while physical labor jobs populate the bottom (craftspeople are somewhere in the middle). If you feel you only have the skills for physical labor, one potential way to move up is to look at a trade that mixes physical labor with basic problem solving, like carpentry, plumbing, electrical work, and so on. If you’ve got such a job and are looking to move up, it will likely require getting more education. In short, always work to improve yourself by learning new skills.

There is some age bias here As I mentioned above, younger people are inherently hamstrung by the wealth column, as most of us twenty and thirtysomethings are dealing with a very large debt load and not that many years in the workplace building up our wealth. In other words, the longer you’ve been earning money and not spending more than you earn, the more likely you are to be moving up in class due to the net worth bias.

This tool lays out exactly how to get ahead in America: get an education, constantly look for ways to improve yourself and aim upwards, and spend less than you make. If you do those three, you will move up through the classes. The people that fail to do these things are downwardly mobile.

Savings accounts are wonderful places to keep money that is very liquid (meaning you can get it if you need it) and earns a small rate of return with very little risk. Because of these factors (liquid, low risk, some return), they are great places to store emergency funds, which is a fundamental part of any personal finance strategy. An emergency fund is a buffer to prevent budgetary disaster in the event of a personal crisis.

This inspired the following question from a very faithful reader who sent me an IM less than five minutes after that article was posted:

It seems to me like it is always good to put your money in a savings account that earns 5% like HSBC Direct. Why would you do anything different?

As I mention, there are indeed a lot of advantages to savings accounts. You can get at the money at your convenience, it can make a nice return in the right account (HSBC Direct, for instance, has a 5.05% APY and some smaller banks do better than that), and there’s very little risk as the account is insured by the FDIC up to $100,000. It is without a doubt a stellar place to put your cash that you may need in the short term.

However, once your savings reaches a point that is out of the reach of your emergency fund needs (at least a few months’ worth of salary), it’s time to start looking for a place to put your money for the long term. For example, the Vanguard 500 has returned an average of 12% a year since 1976, but that return isn’t guaranteed year in and year out – some years have had a net loss, while others have had returns far above 12%. It’s still reasonably liquid in there, but you can pull out at any time (we’ll not get into the taxes on your gains here, but at most you’ll have to pay the same rate as your normal income and it may be substantially less than that). There are many real estate investments that can return spectacularly, too.

Why do this? The potential returns are too good to pass up. If the Vanguard 500 continues along at the historical rate, the money in it doubles every six years, while in a 5% savings account, your money doubles roughly every sixteen years. Let’s say you put a dollar into the savings account and a dollar into the Vanguard 500 and waited 20 years. The savings account would have $2.65 in it, but the Vanguard fund (if it continues at the historical rate) would have $9.65 in it. Multiply those by a thousand or ten thousand and you’ll see why it’s a big deal.

So why not just invest everything in the Vanguard 500 or another investment if it returns that kind of money? The reason is that it’s not insured and it’s far from a guaranteed return. There have been many years where the Vanguard 500 has lost fistfuls of money (the returns from 2000-2002 were positively nightmarish, with 20% losses) – the positive numbers are only over the long term because the good years overall outweigh the bad. On the other hand, a savings account won’t lose its value – it will just stay there and chug along quietly for you, keeping your money quite safe for you.

In other words, keep enough in the savings account so that your short term needs and emergencies can be met, then take the rest and play with it for the long term by investing it somewhere.

Today, Yahoo! launched their Yahoo! Green initiative, which lets you choose from an enormous list of minor lifestyle changes that can reduce your carbon dioxide emissions. It has a slick, cute interface that lets you drag and drop the options from the big list onto one that lists the items you’re willing to do, and it automatically calculates how many tons of carbon dioxide per year that you would save by doing those things.

So why write about this on a personal finance site? It’s because a lot of these items on the list not only reduces your personal carbon dioxide emissions, they also save money. I went through the entire list of items and selected the ones that were really simple to do and also clearly saved money in the long run (I didn’t include ones that were ambiguous to me about money savings). Here they are:

1. Switch 3 lights that you use for 4 hours a day with compact fluorescent bulbs.
2. Replace a porch light that’s always on with a compact fluorescent bulb.
3. Turn your heater thermostat down 2 degrees in winter and up 2 degrees in the summer.
4. Install a programmable thermostat to adjust your home’s heating and cooling automatically.
5. Make sure your walls and ceilings are well-insulated.
6. Air-dry your clothes in the spring and summer instead of using the dryer.
7. Set your water heater thermostat no higher than 120 F.
8. Replace bathroom and kitchen sink facets with low-flow models.
9. Install low-flow showerheads.
10. Go from 500 sheets of 0% recycled computer to 200 sheets of 100% recycled paper.
11. Drive less aggressively — don’t accelerate and brake rapidly.
12. Drive the speed limit.
13. Keep the tires on your car adequately inflated. Check them monthly.
14. Drive 10 miles less per week.
15. Carpool, take public transit, or telecommute one day per week instead of driving to work.
16. Replace your old refrigerator with a new Energy Star one.
17. Replace an old TV with a new Energy Star one.
18. Replace your old dishwasher with a new Energy Star one.
19. Replace an old computer, monitor, and printer with new Energy Star ones.
20. Replace your old washing machine with a new Energy Star one.
21. Recycle all steel (”tin”) cans, aluminum cans, and glass containers.
22. Take one less short domestic round-trip flight this year.
23. Take one less cross-country round-trip this year.
24. Use a washable mug for your morning coffee instead of a Styrofoam cup (assuming you can get a freebie coffee mug).
25. Get a reusable water bottle instead of disposables (again, assuming you can get a freebie water bottle).
26. Buy products in the largest size you can use to avoid excess packaging.
27. Use washable plates and utensils for takeout dinners and parties instead of paper and plastic goods.
28. Buy vintage clothes instead of new stuff at the mall.
29. Unplug electronics when you’re not using them.
30. Turn out the light when you leave the room.
31. Shut down your computer and peripherals each night.
32. Run the clothes washer with only full loads.
33. Wash your clothes in cold water.
34. Run the dishwasher with only full loads and let dishes air-dry.
35. Take showers instead of baths.
36. Take shorter showers.
37. Insulate your water heater.
38. Clean or replace dirty air-conditioner filters every three months.
39. Replace old windows with double-pane windows.
40. Use a push lawn mower instead of gas or electric.
41. Change your car’s air filter and check it monthly.
42. Turn off the car instead of idling.

Whew! All together, these options would save 7.38 tons of carbon dioxide per year, and all of them would save money in some fashion, either by reducing your energy bill, reducing your water bill, improving your gas mileage, cutting down on unnecessary things (like trips), reusing things more often, or by literally making money by recycling items. It’s very difficult to calculate exactly how much money you would save because of the variables, but these items will save money.

You could also use these items as the basis for your own 101 Goals in 1001 Days list. Just make sure to think about which of these items would work well in your life, and also be sure to quantify them so that the goal is clear, like “Move to taking five minute showers” and then using a wind-up timer to ensure that you’re doing this.

Use automatic savings plans The biggest trick of all is to make savings automatic. I have a number of automatic savings plans that withdraw from my primary checking account on a weekly basis and put funds elsewhere for various priorities. For starters, try building up an emergency fund by opening a savings account, then setting up an automatic withdrawal from your checking account into this savings account, a small amount each week that you can choose to increase later.

Use automatic investment plans Similar to the idea of an automatic savings plan, I basically just withdraw an amount from my checking account each week to help build my portfolio. Again, the same logic: if I make it automatic, it takes no special effort from me and I nearly forget about it.

Have an emergency fund Everyone is going to eventually have some sort of disaster strike their life: car trouble, a washer that suddenly dies, and so on. Having an emergency fund in a fairly easy to access place makes it so that the emergency doesn’t drown you. A friend of mine keeps her emergency fund literally in a glass piggy bank in which she shoves $20 bills regularly. If something bad happens, she smashes the bank and gets the cash to take care of the problem.

Get rid of your high interest debts before jumping in too deep Aside from having an emergency fund (which is itself a mechanism to avoid high interest debt), you’re much better off devoting money to getting rid of high interest debt than for saving for the future. High interest debt will be an albatross around your neck for as long as it exists – focus on getting rid of that before saving up big wads of cash for the future.

Start small, then slowly ratchet up the automated savings At first, I couldn’t believe that I would ever survive by having this money disappear automatically – it seemed like I was barely making ends meet as it was. So I started off very small, and I realized that by having less money to work with, I simply learned how to make it work and it quickly seemed “normal.” Since then, I’ve slowly ratcheted up the savings until I’m now putting away close to half of my salary in a given month. The amazing part is that I still don’t really miss it.

Make it somewhat difficult to access the money Put the money into a savings account that you can’t easily access: no ATM card and no local branches are good things because then you won’t easily spend the money. Investment accounts are also good because you get walloped with a tax bill if you get greedy in the short term.

Make the investments easy If you’re not investing because you’re stressed out over the number of options, just go with something basic and easy. Get a very basic index fund that’s easy to track. My recommendation is the Vanguard 500 – you can know how it’s doing every day by simply watching the S&P 500, it’s diversified, and you’re barely paying any fees at all by investing in it.

Know your goals Set clear intermediate and long term personal finance goals so that you know what you’re working for.

Try different things to see what works for you As one of my oldest friends once said, “Frugality is a four letter word.” Many people want to live the “good life” and in their minds frugal living is incompatible with that. I couldn’t disagree more – trying new things is always fun, and frugal and free things are just a part of that. If I find something I really enjoy that happens to be inexpensive, why not incorporate it as part of my routine? The end result of doing this regularly is that your life just becomes less expensive, but no less enjoyable (in fact, for me it’s more enjoyable because the stress of paying bills and paying off debts is largely gone).

At the time, I thought that I was having a great time and making memories for a lifetime, but when I look back on things like that, I just shake my head and wish I had it to do over again. The best part of the experience was spending time with friends, not dropping almost a thousand a night on a hotel room and watching a paycheck that could have been building my future flutter away into the night. That third paycheck in the month could have been something to build a foundation with – instead, I used it extremely poorly, something that I began to regret even before my financial meltdown.

Along thise lines, a reader sent in this interesting question recently:

Like many others who are on a bi-weekly pay period, I have three pay periods coming up in June. Any suggestions on a strategy for best utilizing this occurrence?

Here are the options I would recommend, starting with the best choice.

Pay off debts This is really only effective if it comes with a commitment to eliminate debt, but if you truly are committed to eliminating debt, using the third paycheck solely as a debt elimination tool is the best option. This is especially true for high-interest consumer debt. Use the check to pay off the higest interest debts you have and make a commitment to avoid credit card debt and other consumer debt.

Create an emergency fund An emergency fund is a wonderful thing to have because it protects you against the unexpected: a car breakdown, a washing machine replacement, a job loss, and so on. In essence, just take the check, toss it into a high-interest savings account, and wait for a rainy day to use it – it can transform a disaster into a mild discomfort.

Invest it This is a great option if you have a long term goal. Put the money into an index fund and just forget about it until you need it. It will ride the market until you need it in ten or fifteen or twenty years, whenever you’re ready to spend it.

Save it On the other hand, if you have a clearly defined medium term goal (like buying a car), it would be worthwhile to save it for that purpose. Put it into a savings account and wait until you’re ready to make the move.

Spend it on capital improvements This means investing it on some sort of home improvement project, something that holds value. Repaint a room, have some new siding installed, or something that improves the value of something that you own. This won’t help much in the now, but it will help in the long run.

There’s also the option of donating it to charity, but this option is highly dependent on your own personal values.

The worst option, from a personal finance standpoint, is simply spending it on something fun and immediate, but there are other perspectives to consider and money spent on fun stuff if you have your financial bases covered can be well worth it.

In short, what you should do with that check depends on what your financial state is like. Spend some time considering what to do with it – just don’t spend it on something that will fall through your fingers like sand.

But why is that? Let’s take a step back and look at what’s actually going on here, piece by piece. Some of this may seem very basic to some of you, but it provides a good illustration of why exactly inflation is important.

Compound interest In the past, I’ve talked about the power of compound interest and even described how to make your own simple compound interest calculator, but here’s a quick refresher. Compound interest refers to the idea that when you earn interest on an investment, that earned interest is rolled back into the investment and starts to build on itself. Let’s look at an example.

Let’s say you have $100 and you put it in a savings account that earns 5% each year, compounded annually. At the end of the year, you earn $5 in interest and it’s put into the account. The next year, thus, you’re earning 5% on the new $105 balance. At the end of the following year, you’ll actually earn $5.25, giving you a total balance of $110.25 at the end of the year. Notice that the earning has gone up, even though the investor hasn’t done anything more than just leave the money in place? That’s the power of compound interest.

Using this same example of annual compounding, after 20 years, the account will have $265.33 in it, and it will have earned $12.63 over that final year. If you multiply these numbers by, say, 10, you’ll see what a $1,000 investment would look like, and so forth.

Inflation Inflation, however, works in the opposite direction. You’ve heard tales before of gasoline for $0.50 a gallon and such, right? The increase in prices over time is inflation, and it basically means that a dollar today simply does not buy as much as it once did. For the last several years, inflation has held at about 3% annually, so let’s use that as the example here.

Let’s say you have $100 and you put it under your mattress. A year from now, that $100 will only be able to buy what $97 did the year before. Leave it there for another year and it will only be worth $94.09 in today’s dollars. Twenty years? That $100 bill will only be worth the same as $54.38 is today.

Combining the two In the real world with a real investment, you have both forces at work on your money, and that makes the picture a bit more complex. For example, if you put $100 into an HSBC Direct savings account, it will earn 5.05% APY, and thus in twenty years it will have a value of $267.87 when you check the account balance. However, if inflation stays at 3% for the next twenty years, a dollar will have the same value as $0.54 today. Combining those two factors, your nice HSBC Direct account balance will actually only have the same value as $145.67 does today.

What about taxes? Taxes basically only effectively reduce the interest rate that you earn. So, for example, let’s say you pay 28% income tax on interest. That means that your effective interest rate on that savings account is 3.63% after paying out the income tax each year. If you use that as your interest rate, after twenty years, your $100 will have turned into only $111.09 in today’s dollars. Basically, any savings account that earns a return less than 4% or so is actually losing value over time because of the effect of taxes and inflation.

What can I do? Realize what a savings account actually is: a place to hold your money. Even a high interest one like ING Direct or HSBC Direct basically just keeps your money at its real value over time (meaning that the amount of stuff that you could buy with the money you deposit will be the same when you withdraw the money and the earned interest). If you want to strongly beat inflation, you have to look at other investment opportunities.

So why save? The point of saving is to ensure that you have money in the future while you have a surplus now. This saving enables you to make large purchases in the future or ensures that if bad things happen you’ll still have a comfortable life. If you want your money to earn money, then you need to invest your money – and investing money is an entirely different ball of wax.

I’ve installed CFLs and programmable thermostats, but what I’d really love to do is to be almost exclusively reliant on my own energy production, with the ability to sell excess back to the grid on windy days and pull in a bit of electricity on very still days. I happen to live in an area where several school districts within an hour’s drive, as well as a dozen or so individual homeowners, have installed their own Skystream wind turbines for electricity generation.

How big are they? They stand about forty feet high, tall enough to be well over the roof of a three story home. In other words, it would roughly be twice as high as the roof on a two story suburban home, for example. These are tall enough that you have to check around for local zoning issues to see whether or not you can put such a structure in place (they’re perfectly fine over almost all of Iowa, for example – I checked).

How much power does one generate? For a Skystream to be fully functional, you need to live in an area with wind that averages 10 miles per hour or more; on the Great Plains, this isn’t a problem, as you can see from this wind map of Iowa for a recent month. You can easily find wind maps for your own state as well.

Given that, a fully functional Skystream wind turbine produces 1.8 kW of power in a 20 mile per hour wind. To put that in context, that’s just under 1,300 kilowatt hours a month. For comparison’s sake, we used approximately 600 kilowatt hours of electricity last month – and this included a particularly vicious cold period where temperatures sunk below zero for a period.

Power excess? When you install a home wind turbine, it is hooked up to your power meter directly and power is drawn first from the turbine, then from your normal electricity provider (the electric company). When the wind is very low, almost all of your power comes from them and your power meter works as normal, recording the kilowatt hours you use from the electric company. As the wind picks up, more and more electricity comes from the turbine and less and less from the electric company, until a point is reached where all power comes from your turbine. If the wind blows faster than that (10 miles per hour or more), then the turbine will produce more energy than your home is consuming. The rest of it goes onto the electrical grid and helps to power your neighbor’s homes. Even better, the electric meter at your home will run in reverse, crediting you for the electricity you supply.

I have a friend who has an electricity credit every single month, more than enough to cover the basic fee of his electrical hookup. Annually, he receives a small check from the electric company for the credit he has accumulated with them. Yes, he has no electric bill at all and actually receives a check for it.

What’s the cost? A Skystream 3.7 (the wind turbine that has been recommended to me and the one I have researched most thoroughly) costs about $8,500 to purchase, install, and set up in my area. Installation costs in other areas are higher, ranging up to $12,000.

Ouch! How much can it save a month? Let’s say, hypothetically, that your local rate for a kilowatt hour is $0.10 (the national average is actually $0.11). Let’s say the turbine works at half-capacity and generates 650 kilowatt hours a month. Thus, the turbine saves $65 per month on your energy bill. At that rate, you will pay for the turbine with the energy savings in 132 months, or roughly eleven years. This assumes, of course, no increase in energy rates over that time, it assumes energy costs that are already below the national average, and also assumes a relatively low windspeed compared to what is available to me in northern Iowa. According to my own math for my area, and also assuming an increase in energy costs that matches inflation, we would be able to pay it off in about seven years.

Are there other benefits (besides for the environment)? There also may be state tax benefits for installing such a device; Iowa residents can buy the equipment and pay for the installation with no sales tax and can earn $0.01 in credit for each kilowatt hour of energy sold back to the electric company, even if that results in just a reduction of your bill (please note that this is my understanding of the law – don’t use this as the basis for an installation). Thus, if you could sell back a few hundred kilowatt hours a month, you would earn a $30 or so tax credit each year.

The bottom line is that this is a major step one can take if they’re really interested in green solutions. Even better, it can end up paying for itself and more, resulting in not only doing the right thing for the environment, but doing the right thing for your wallet as well.