When it comes to saving and investing, it helps to have a system. My family has developed our own system of saving money that has allowed us to reduce our spending and direct more of our money toward long-term goals.
In a sense, this system is similar to the famed “snowball” debt-reduction approach in that it focuses a person’s attention on small, achievable goals. But while the snowball method is geared toward paying down small debts before large ones, our method is more focused on saving money in small increments, and hoping that small gains eventually turn into large ones.
My system does require some discipline and it can be challenging. But the challenge is part of what can make the system fun. (See also: 7 Smart Money Challenges You Can Totally Do)
1. Track your spending
We use credit cards and debit cards for most purchases, allowing us to have a real-time record of what we’re spending. Our credit card company does a good job of placing our expenditures into categories such as “restaurants,” “automotive,” “grocery,” and “entertainment.” Account aggregation websites such as Mint and Personal Capital can help with this as well. (See also: These 5 Apps Will Help You Finally Organize Your Money)
2. Find monthly averages
Once your spending is tracked and categorized, it’s time to do some math. Your goal should be to determine what you spend in each category each month, on average. I like to find the average over the previous 12 months, but a six-month average is also OK. Once you determine those averages, save them into a spreadsheet. Each of those numbers is now your starting monthly budget for those categories.
For example: Let’s say that you have spent $1,000 eating out at restaurants over the last 12 months. That averages to about $83 per month. Your goal for the upcoming month should be to keep your restaurant spending under $83.
It’s important to also include monthly averages for large, but irregular expenses. Perhaps you spent nothing on auto repairs during 11 months out of the year, but spent $2,400 in July. In this system, it’s prudent to budget $200 per month for auto repairs so that you have money saved if you encounter a similar expense.
3. Beat and lower your averages
We all know it’s not good enough to be average. You want to be better than average, right? So your goal each month should be to spend less — significantly less, if possible — than your monthly average. You may not be able to beat your average in every spending category, but you’ll likely spend less in some places and hopefully lower your spending overall.
If you spend less than your average in a given month, the next step is a crucial one: It’s imperative that you lower your goal based on your new average. In other words, if your goal was to beat your average $50 in fast food expenses during the month, and you find that you’ve spent $40, it’s time to recalculate your average and make that the new goal. Embrace the challenge!
4. Try to beat your best
If you really want to challenge yourself to save money, adjust your monthly budgets even lower to have them in line with your best month, not your average. We all have that one month where we impress ourselves with our financial discipline. Maybe you went an entire month only going out to eat once. Perhaps you had one month where you were super about saving energy. Find that month, and make that the new budget baseline. If you can beat that number on a consistent basis, you’re doing awesome.
5. Savor the small victories
One of the reasons I like this system is that it allows you to zero in on specific parts of your finances without getting overwhelmed by the big picture. It can be demoralizing to look at your total lump sum of expenses and debt and feel like you’re not getting ahead. But if you are focused on reducing spending in various categories, you have many opportunities for small wins. Even if your overall spending didn’t decline much during a month, you can feel good that you spent less on groceries, or found ways to reduce your electric bill. That good feeling can be contagious, and before you know it, you’ll find that you are spending less overall.
6. Treat saving like an expense
My family makes a point of putting away a set amount of money each month into a variety of separate savings and investment accounts. There is money directed toward Roth IRA accounts, some funds placed in 529 College Savings plans, and another amount put into an online savings account with a higher interest rate. We also set aside money for big ticket items, such as a new car. When we track our spending, we treat these like expenses. Only in this case, we are treating these costs in the opposite way we treat our day-to-day expenses. Rather than reduce this number, we want to increase it if possible. So if you’re putting $100 a month into an IRA, try to bump that up to $110 or $125. This may require you to reduce your spending budgets in other areas, but that’s the whole point, right? (See also: 5 Retirement Accounts You Don’t Need a Ton of Money to Open)
7. Pay down debt or add to savings
This system is all about saving money, so if you reduce your spending in one area, it’s a bad idea to go and increase spending somewhere else. If you find that you have spent less in one category in a given month, use that money to pay down debt faster or increase your savings investments. Let’s say you spend $25 less on groceries this month. Well, think of that as $25 more to pay off your auto loan, place into your IRA, or fund your college savings account. (See also: 5-Day Debt Reduction Plan: Pay It Off)
8. Keep an eye on new expenses
No matter how maniacal you are about saving, there will be times when you are forced to increase spending in some areas. If you have a child, rest assured you will be spending more on food, clothing, and a host of other things. If you have an older car, you may find yourself paying more for repairs. You may get a new job that adds income but also commuting costs. It’s fine to make appropriate adjustments to your budgets as you go, as long as you eventually settle into a practice of trying to reduce spending and boost savings whenever possible.
9. Throw new income into savings
This system is all about reducing spending and finding ways to shift your money from costs to savings and investments. Income is not irrelevant, because you need to know how much you have to work with. But you should try to avoid making grand changes to your budgets if you get a boost in pay. Any new money you have should be used to increase savings, pay down debt, or invest. It should not be used to increase your individual budgets. If you got by spending $200 on groceries before your pay raise, you can get by on that same amount now. (See also: How to Budget When You’re No Longer Broke)