There is an old story about two colleagues talking during a break at work. One of them is a smoker and the other one isn’t.
The nonsmoker asks the smoker how long he has been smoking. Between puffs he replies, “About a pack a day for 30 years.”
The nonsmoker, obviously a personal finance nerd, does some quick calculations and informs his colleague that if he had not smoked during that time, and instead invested the money he saved, he would have enough money by now to buy a brand new Ferrari.
The smoker, initially impressed with this idea, thinks for a moment and then turns to the nonsmoker and asks, “So where is your Ferrari?”
Funny, but also enlightening. The message is clear: saving money doesn’t do you a lot of good unless you actually save the money you saved.
Throwing Money Out the Window
After living in our house for almost 30 years we finally replaced our windows last year. New windows certainly make our house look better, which makes my wife and daughter happy, but the biggest selling point for me was that new windows would save us money on our utility bills. The old windows were extremely inefficient. We were, in effect, throwing money out the window.
After we replaced the windows I was curious as to how much we would save, so I set up a spreadsheet to track the savings. Each month I compare our utility bills to what they were before we replaced the windows and calculate the difference. Then I made the wise choice to actually save the money we saved by transferring the difference to a Capital One 360 savings account I set up and named “Energy Savings”.
This month marks a year since we replaced the windows and we have $725 in our savings account. That is not quite as much as I had hoped to save, but not bad. And the best part is that it was practically painless. We are not spending any more or less per month than we were before; we are simply saving our savings.
If we hadn’t made a plan to capture the savings, we still would have saved $725 on our utility bills, but it would have disappeared as silently and easily from our bank account as air used to escape through our old windows. And it probably would have done us about as much good.
After several years of doing this we will have a pretty good chunk of money in our “Energy Savings” account. Not enough to buy a Ferrari, but perhaps enough to pay our house off a couple of years early or add a significant amount to retirement savings.
Remember, if you don’t actually save the money you saved when you save money, you are not really saving money. Just spending it differently.
A Current Opportunity to Save
A related strategy to increase savings is to save more as you make more. When your paycheck increases, simply save most or all of the growth.
It just so happens that most of us will get an unexpected chance to do this immediately. The recently passed tax law gives 80% of Americans a tax cut, and those tax cuts will be reflected in lower withholding of federal taxes from your paychecks starting this month.
I just received my first paycheck since the withholdings were adjusted and it was $60 higher than what I took home in my last paycheck. Since I get paid twice per month that is an increase of $120 per month. If I save that amount each month I will have saved well over $1,000 by the end of the year.
I strongly suggest that right now, before you have a chance to get used to the extra money, you calculate how much your increase is and set up an automatic transfer of that amount to a savings account. You survived last month without that unexpected windfall, and you can do the same the remainder of the year.
A Word of Warning
I do, however, have a word of warning. While 80% of Americans are expected to get a tax cut, 90% of workers will see their paychecks increase this month due to the adjusted withholdings.
That means some of you are going to get an unpleasant surprise when you prepare your 2018 taxes next year. Your tax bill will not have decreased, but your federal tax withholding would have, leaving you owing money or getting back less than you expected. This is another good reason to save the windfall. That way you will have the money to cover any unpaid taxes.
A better solution if you think you fall in this category is to adjust your withholding allowances so the same amount of money is taken out of your paycheck as before the change. This is what I plan to do.
Due to limits on deductions in the new tax law I expect my taxable income to increase slightly but I will be paying a lower tax rate. As near as I can tell this will probably be a wash for me and I will end up paying about the same amount in federal taxes as before. Therefore, rather than saving the windfall, I am going to adjust my withholdings so I am having as much taken out in federal taxes as before. If you are in a similar situation and don’t know how to do this talk to your HR department.
That was kind of a detour, but I thought it was important to provide this warning now while you still have time to do something about it.
Painless Saving
Now back to the regularly scheduled program. While saving is never completely painless you can eliminate most of the pain if you increase your savings immediately after lowering expenses or getting a pay raise. So if you have been figuratively throwing money out the window, make a change now to eliminate the waste, and then take the steps to actually save the money you saved. Otherwise you are not really saving money. Just spending it differently.