When paying off a ton a debt aggressively you need to maximize your savings as much as possible. In fact, I’d say, whatever your goal is that you need to maximize your savings so that you can let time take care of the rest. The best way to maximize your savings is to automate it to ensure that you are making progress to avoid delay in reaching your goals.
By automating your savings this essentially takes the money out of your hands and puts it is a safe place until you need it. It doesn’t have to just be retirement savings such as a 401K, but rather any type of savings that you can apply towards goals such as debt payoff, emergency funds or a house down payment.
One of the biggest problems you might have had in the past with paying off debt/saving is that while you intended to put your money towards debt/savings at the end of the month you end up with less than expected or even nothing left over. This of course is a problem because you knew that you should have had that extra money at the end of the month.
PAY YOURSELF FIRST
So, to ensure that you save what you want for that month you simply pay yourself first. This means when you get your paycheck that the first thing you do is put aside the money you are wanting to save that month and then use the rest to cover your expenses. Obviously, the amount you save needs to allow you to live off of for the rest of that month. If you have any money leftover you can always add that back to your savings to pay more off but the key is to simply get that money out of your hands so that you don’t spend it. If you have a tithe or giving that is important to you this is a great way to cover that cost if you find yourself in a similar situation of not having enough to tithe at the end of the month.
Here are some steps you can take to make this happen.
TRACK YOUR EXPENSES/BUDGET
Before you set up your automation you need to understand how much you can afford to set aside each month. This process is a form of automation in an of itself so take advantage of it if you are not already doing so. If you are going to automate your savings you need to do so with an informed number to avoid not having enough to take care of your planned expenses each month. The key word there is planned expenses. You need to eiminate expenses that are done on a whim because “you deserve it.” Trust me, it is way more fun to be in control of your money.
I would suggest starting smaller with the amount you set aside and adjust as you get a couple months under your belt. As you continue though feel free to get more aggressive and push yourself each month to see how much you can reduce your spending to save more.
- Track your expenses using a site such as mint.com and in the process, scrutinize every expense you’ve made to find the areas you can cut. On a side note, take a close look at recurring items especially. Examples might include your cell phone, cable bill, etc. These are automatic expenses that you could reduce/cut to create significant savings over the year. Remember to automate your savings and don’t automate your expenses!
- Put together a typical monthly budget based on these actual expenses. Save room in there for expenses that occur on a quarterly or yearly basis. You can either take care of these as they individually occur each month or you can save up for them each month by, you guessed it, automating your savings!
- Once the budget is set up you will need to keep an eye on your purchases since sometimes you need to recategorize them but either way, this is your chance to review your spending and see if you are on track to meet your budget.
While your spending is automatically pulled in you need to be actively involved in reviewing these items to keep your behavior in check. As much of this process is handled for you it is your job to be aware of where your money is going and whether you are on budget or not. Automatic does not mean out of touch!
Now that your budget is in place and you are tacking your expenses you are ready to start saving to pay off debt each month. Keep in mind that this is for extra payments, not the minimum payments. Depending on your billing cycle, you’ll want to be able to make your minimum payments during the month so you wouldn’t include that in the money that you are setting aside each month.
- Set up a high interest savings account to keep your money in that you intend to pay off debt with. Most don’t require a minimum balance other than $0 or $1 so no excuses that you don’t have enough to start it.
- Direct your paycheck to 2 accounts – If you direct deposit your paycheck to your checking account then you can easily go to HR and request the form to also deposit a portion of that paycheck into a second account. I suggest this being the high interest savings account mentioned above. This keeps it out of sight and out of mind until you need it. When you are ready to make an extra payment simply pay from that savings account or if that is not possible transfer it back into your checking account and pay that debt off! We recommend doing this monthly and not waiting until you save up the full amount of the debt owed. This reduces what you pay in interest but that is a whole other post to explain why.
- If you don’t have the option to direct deposit your paycheck then when you deposit any paycheck you can set up a transfer from your checking account to your high interest savings. Set it up so that it transfers the money after your paycheck clears. For example, if you get paid on Friday, set the transfer up for Saturday to avoid any problems of over drafting.
- If you have irregular paychecks you might prefer to manually transfer it each time you make a deposit to ensure you don’t overdraft. One way to remind yourself would be to set up a weekly reminder on your calendar to remind you to transfer any money you want to save that month. It is not as efficient but it is better than nothing.
If for whatever reason there is a part of the above process that you can’t automate, such as the irregular payment scenario, or you just want to automate other parts of your life that you repeat find an app that reminds you when to do these things. On my iPhone there is a built-in app for reminders that I use a lot. This helps clear my mind and I know I won’t forget those items. There are lots out there so find one that works for you but it really is a great way to keep on top of things without exhausting your brain in the process.
Once you’re debt free it is time to build up the emergency fund to 3-6 months of expenses if you have not already done so. The best place to keep that money is in a high interest savings account and you can basically follow the steps above to regularly add money to that account. This time you get to keep the money in there though. Yay!!!
HOUSE DOWN PAYMENT
Similar to the emergency funds a high interest savings account is where we kept the money we used towards our house down payment. At this point we deposited Erin’s whole paycheck into this account to go towards the savings. That was huge for us and is a big part of why I suggest to set up these automatic transfers. We had our emergency funds and down payment in the same account but if it makes you feel better you can keep 2 separate accounts.
There are a lot of similarities with what we have already discussed so when you are ready to invest we suggest automatically contributing to these accounts.
- 401K – 401K’s are funded by direct depositing money from your paycheck into your 401K account. If your employer offers a 401K we highly recommend you taking advantage of it, especially if they offer a match. Once you are eligible, you can set it up and choose what percentage to contribute. If you have debt and are actively paying it off we suggest just contributing the minimum in order to collect any company match as that is free money. That allows you to take the rest of your money and put it towards debt. Once debt free you can save more in the 401K. Besides getting the free money, putting some money in your 401K on the side while paying off debt will be a nice bonus once debt free.
- Post-Tax Accounts or an IRA – For post-tax accounts (i.e. accounts you fund with post-tax dollars) or an IRA you can set up an ACH or a transfer on a bi-weekly or monthly basis to the company you have your accounts with. Naturally when setting up the accounts you would set up the initial transfer of funds through an ACH or transfer, but the point here is to also establish regular periodic transfers to ensure that you continually fund these accounts.
In summary, you’ll find that you are basically doing the same thing whether you are paying off debt, saving for a short-term goal or investing but getting into these habits of automating these processes provides a good mix of being on top of your money without overly obsessing about it. With that said, see what you can do today and just do it. You’ll thank yourself later for it.
Automation really does play an important role in getting out of debt. We started something a little different, though. We automate all of our bills, including the minimum payments for our debts. At the end of the month, we gather all of the extra funds we were able to squeeze out of our budget, and make an extra payment on those debts.
We’ve never really gotten into automating our bill pay because we like a little more control over exacty when we make those payments in relationship to our cash flow. Your approach though at the end of the month is exactly what we did during our debt payoff and it worked well although there were a few months we could have done better and would have benefited from something like this. After that though we started this and I wished we had started sooner because it helped cut down on those periods of not being as efficient with our money.