Not all that long ago, if I wanted to spend money, I’d look at what was left in my checking account and spend it. I knew in the back of my mind that I should be saving some money, but I never looked at it as a requirement at all. It took me a while to grasp the idea of an emergency fund and that saving up for big purchases is a huge money saver.

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.

A couple years ago, an extremely influential article entitled A Simpler Way To Save: The 60% Solution popped up on MSN Money. It proposed a very simple way to budget:

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.

Today, I stumbled across a very interesting tool at the New York Times website that attempts to place you in one of five socioeconomic groups (upper fifth, upper middle class, middle class, lower middle class, bottom fifth) based on a number of factors (occupation, education, income, and wealth). I’m quite happy to share my results with you:

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.

Over the weekend in a post answering anonymous reader questions, I wrote the following:

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.

I admit to being an environmentalist, and a pretty “far out” one, too - I was raised with a Mother Earth News / Organic Gardening type of father who instilled a ton of basic environmentalism in me, and I try very hard to reduce my environmental footprint. Let me put it this way: one of the biggest things I’m looking forward to when having my own house is having a few giant compost bins in the backyard with potato peels and coffee grounds and yard clippings and earthworms and so on.

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.

It’s pretty easy to save money over a short period - just make a savings deposit and feel good about yourself, right? The real challenge comes over the long haul - how can you make yourself do it consistently and also not be tempted to spend the money? Here are nine tricks I use to make it happen.

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 one point in my life, I was on a biweekly pay period schedule that occasionally caused me to be paid three times in a month. Of course, at that time in my life, I was an utter fool and I would spend the money on a big splurge, like, say, a weekend trip to Chicago with four friends in which we stayed in a huge suite and also had box seats at Wrigley Field.

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.

Last week, I wrote a pretty harsh criticism of Spend Every Dime!, a Slate article that basically encouraged people not to save money because taxes and inflation eat up most of the gains.

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.