Savings is one of the most basic concepts in personal finance…or so we think. While the rewards of saving money are obvious, actually following through often proves to be a challenge. Even when people understand its importance, savings is made difficult by the fact that everyone’s situation is different. What works for one person might be totally unmanageable for you.
Below, we explore several different approaches to savings (and the pros and cons of each) to help you pick the right one.
Sporadic savings is the default approach of most individuals. In lieu of any specific plan or system, they simply put various amounts of money away at random times when it’s convenient. There are any number of reasons why this is not the ideal approach. Over the long term, it is sabotaged by human nature, our reluctance to delay gratification, and the overall lack of consistency inherent in the approach.
That said, there are some people who would be well-served by sporadic savings. For those with irregular or unpredictable income (say, freelancers) putting money away randomly is infinitely better than not saving at all. Likewise, individuals living paycheck-to-paycheck on extremely tight budgets should certainly save when they can if the only other option is not saving. That said, sporadic savings should be seen as a temporary “stopgap” solution, used only to tide you over until you have steadier income.
The polar opposite of sporadic savings is scheduled savings. As the name implies, this refers to any savings system that is automated, such that a fixed amount of money is being saved each month or pay period. This approach is vastly superior because it removes guesswork and volition from the process. Essentially, savings comes to mirror an assembly line that functions like clockwork to gradually build your wealth.
Scheduled savings is ideal for anyone whose income is both steady and sizeable. If you have excess cash left over after paying your routine bills (and other obligations like retirement, investments, etc.) then you are a prime candidate to set up an automated savings transfer at your bank and let it work for you.
Purpose-driven savings is a hybrid approach. Its defining feature is not the regularity or the amount of savings—depending on the person, these could vary. Rather, purpose-driven savings is about why you save. Very simply, not everyone is motivated by the abstract goal of “savings.” To them, the typical reasons for saving (security, stability, etc.) are just obstacles to buying what they want right now. Instead, these people are much more likely to put money away for specific and compelling reasons: a down payment on their dream home, or their college tuition, for instance.
With purpose-driven savings, your goal is so powerful and appealing that simply thinking about it is enough to make you sacrifice for it. This overcomes the lack of intrinsic motivation to just “save” for its own sake.
The Envelope System
Another solid option for those who find themselves lacking in natural motivation to save is the envelope system. This approach works because of its simplicity. Each month, you decide how much you are willing to spend in each area of your life: bills, entertainment, food, etc.
After doing so, you put those amounts in envelopes that belong to each category. Once you spend each envelope’s contents, you are prohibited from spending anything more in that category until you get paid again and replenish it.
The envelope system is best suited to those who are not naturally “wired” to handle their money. Instead of forcing themselves to mentally juggle their money and responsibilities, the envelopes spell out their spending decisions for them, allowing you to buy whatever you want in each category as long as you only spend the allotted amount.