Step 3 — Start A Savings Plan
You've heard the old adage, "pay yourself first." Well, our experienced bankruptcy attorneys will remind you of this when you've made it through your bankruptcy case. After all, when your debts are gone, you should be able to save each month, as long as you stick to your budget.
When the talk turns to saving, you may well start to groan and think to yourself, "I don't even have enough money to pay my bills. How am I going to find any money to save"? You also may have some of the following thoughts about saving:
- I don't know how to save.
- There is always something more pressing to do with my money.
- I'm young; I can put off saving until I'm in a better financial position.
- I need to pay off all of my debts before I start saving.
These are fair concerns, but they are unfounded. Most people have these thoughts about saving because they don't understand this important rule about saving: it doesn't take a lot to make a lot.
Please read these additional sections to learn the details of how you can start a savings plan:
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Understanding Compound Interest
Albert Einstein supposedly once said that the eighth wonder of the world is compound interest. Einstein was a pretty smart guy, so you would do well to try to understand what he was talking about. What is compound interest? Compound interest is nothing more than interest on interest. In other words, if you put a dollar in a savings account with interest compounded, you will receive interest not just on the initial dollar you deposit, but you will also receive interest on all the interest you receive during the life of your deposit. Although money doesn't grow on trees, it certainly does grow through the magic of compound interest.
Accordingly, whenever you have trouble with saving, or when you think that because you're only able to save small amounts it's probably not worth it, remember the power of compound interest. Here's a short exercise to illustrate the power of compound interest. Do you play the lottery? Do you religiously plunk down $20 every week on your favorite numbers with the thought that you'll never really miss the money if you lose, and that if you win, all of your troubles will over?
Leaving aside the almost overwhelming odds against you that you will ever win a significant amount of money in a lottery (according to most experts, you're more likely to be struck by lightning than to win the lottery), you should think about how your money would grow if instead of spending it on the lottery, you deposited it in a savings account with compound interest. Instead of putting that $20 in the lottery every week, if you deposit that amount every week in an savings account with compound interest at 4 percent, and don't touch the money for 18 years, you will have saved more than $27,000.
In fact, at an interest rate of seven percent compounded annually, (which is lower than the long term rate of return in the U.S. stock market), any money you save today will double in 10 years through the magic of compound interest. And if you periodically add even small sums of money to your initial savings, the amount you'll save will increase dramatically.
The following chart shows how much you'll save after 20 years assuming an initial savings amount of $1,000, an interest rate of 6 percent, and various amounts put away on a monthly basis.
| Initial Amount Saved | $1,000 | $1,000 | $1,000 |
| Interest Rate | 6% | 6% | 6% |
| Years of Saving | 20 | 20 | 20 |
| Amount Saved Per Month | $20 | $50 | $100 |
| Amount You'll Save | $12,276 | $25,879 | $48,551 |
Think about this the next time you buy a lottery ticket!
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How To Save
There are two keys to saving: do it, and do it regularly. The amount you save is much less important than the actual practice of saving (of course, the more you can save, the better), so get started as soon as possible.
In order to get yourself in the habit of saving on a regular basis, you should think about the concept of forced savings. Forced savings is simply the practice of setting up a system whereby you are required to set aside a certain amount of money every month, or where your money is automatically deducted from your checking account and placed into some type of savings account.
You may already be engaging in a type of forced saving. If you own a home and are paying off a mortgage, this is one of the best forced saving program. As you slowly pay off your principal balance, you are building up equity in your home, and this equity will increase as your home appreciates in price. And with all of the tax advantages associated with home ownership, your home may be the best "savings account" you'll ever have.
In fact, you can "turbocharge" your forced savings program using your home by paying extra principal with your mortgage payments. By paying an additional amount of principal with your mortgage payment, you can shave years off your repayment schedule and save thousands of dollars in interest charges as a result. For example, if you have a typical 30-year fixed rate mortgage with an 8 percent interest rate, if you make one extra principal payment per year, you would pay off your mortgage in 23 years rather than 30. You will save much more in interest using this method than the one extra payment will cost. And if you can't scrape together the extra payment in one lump sum, you can simply make this extra payment over the course of the year-in other words, make 1/12 of this extra payment in each month. You'll pay off your mortgage even sooner using this method. Most lenders have specific programs that make this easy for you to do this. If your lender doesn't offer this, ask for it.
There are many other types of forced savings programs. If you are employed and your employer offers a 401(k) or other type of retirement savings program, you should strongly consider signing up, particularly if your employer matches any portion of your contributions. Not only will you start to build up a retirement next egg, because the money you contribute is tax deductible, you will decrease your tax bill. Even if you're self-employed, there are similar programs (Simple IRAs, SEPs, and other tax advantaged plans) that allow you to set aside pre-tax dollars to fund your retirement program.
Even if you're not employed, if you can scrape together some funds to put away, you may want to consider setting up an Individual Retirement Account (IRA). IRAs allow you to set aside money each year that you can withdraw when you're ready to retire. The extremely popular Roth IRA lets you aside money, and also allows you to withdraw the money tax free when you retire. Of course, these retirement programs have different eligibility thresholds, and also can present tricky tax issues, depending on your age, income, and tax bracket. You should consult a tax professional before proceeding with any of these plans.
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You can also start a forced savings plan that will allow you to fund your children's college as well as reduce your taxes. A relatively new college savings program (known as the 529 Plan) allows you to put money into a college account for your children which will accumulate tax free and can then be taken out (again without taxes) to pay for college. In many states, your contributions are tax deductible. As a type of forced savings program, you can have your monthly contributions automatically deducted from your checking account (some states allow you to contribute as little as $25 per month). Also, if you have any money available to start an investment program, you could set up a system of automatic withdrawals from your checking account to purchase investments such as mutual funds or stocks.
Even a plain vanilla savings account can be a great way to start a savings plan. Yes, interest rates are at low levels right now, so you're not going to earn a lot of money this way. But, starting out small like this can help you get comfortable with the idea of saving, making it easier as time goes by to tackle larger and larger projects. Remember, Rome wasn't built in a day, and your savings program will take some time to get traction
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