Here we are at session number 5 , and we’re going to be talking about How to start saving.

Having covered in detail last time about how to stop paying money to other people, i.e. how to get out of debt, it's time to turn our minds to how we pay ourselves in order to build up resources for our own future. We're going to talk about how to save, where to save and what order to do things in for best results.

Click to Listen

Podcast: Subscribe in iTunes | Play in new window | Download

Introduction

Being debt free is a great feeling. There's nothing quite like owing nobody money (except maybe your mortgage) for helping you sleep at night. But we need to take it on from that and begin building up wealth of our own, to help us achieve our long term goals.

I do want to emphasise just how big a deal this is, and how unusual it is in this day and age.

If you have got to this stage, having been in debt – congratulations! You are well on your way to becoming truly wealthy. There's a long way to go yet, but the dedication you've shown so far will stand you in great stead for the future.

If you have paid off debt recently, maybe using Dave Ramsey's snowball technique from session 4, you will be used to setting aside some money every month to pay down that debt.

What to do with that money now? Do you give yourself a pay rise and start to live a little? Well, maybe. But it is better to continue that discipline and keep putting that money aside for your future; you'll thank me later!

Everything you need to KNOW

So, let's deal with everything you need to know about how to start saving

1 – Savings goals should be divided into short, medium and long-term

Generally speaking, either we're saving FOR something specific, or we're just putting money away ‘for the future'.

The longer the term we're saving over, the more difficult it is to be specific about amounts. When saving for the short term, it's easier to be specific. Tend to save towards a monetary target, (need £3,000) for a holiday, rather than just saving. Here are some timescales:

• Short = 1 year or less. e.g. Christmas or holiday
• Medium = 1 – 10 years or more. e.g. New car or a Wedding, or university for kids
• Long = open-ended. e.g. Retirement

2 – The longer the savings term, the greater the impact of inflation

Inflation reduces the value of money over time. Or, put another way, inflation is what puts prices up each year.

There are two main measures of inflation: Retail Prices Index (RPI) and Consumer Prices Index (CPI) they are both measure similarly, using a basket of everyday goods. CPI excludes housing costs like mortgage payments and council tax

Right now, in January 2013, CPI = 2.7% and RPI = 3.1%

Whatever you're saving for will be more expensive in the long run, but in the shorter term, inflation will have negligible tangible effect.

You should factor inflation in when working out how much to save towards a long term goal. May need a financial calculator to do this, or try zenwealth.com

3 – Cash is not an investment

By cash I mean bank/building society accounts, and cash-like investments like some National Savings products.

These generally offer paltry rates of return, usually below the rate of inflation. That means it is costing you money to save there. Bank accounts are therefore only useful for holding short term money, not for investing long term.

What is short term? Say less than five years a a good rule of thumb.

So, knowing those things, what do you need to do to begin saving towards your future?

Everything you need to DO 

1 – Finish off your emergency fund

What? I thought we were saving for the future!

An emergency fund gives you a cushion should you need it in the future. I've heard it called ‘screw-you' money – it's a cushion so that you can tell your boss to stick it if you want!

We started our emergency fund in the getting out of debt phase – we set aside £1,000 before we began paying down the debt. Now we need to make sure that emergency fund is at the level it should be long term.

How much should you have in your full emergency fund? A good rule of thumb is 3-6 months net income. But which is it – 3 or 6 months? There's a big difference between the two.

• If your job is ‘secure', you've been there a long time, or you have good sick benefits, then maybe you can just keep 3 months' income aside
• If you are self-employed or working for a small company with poor benefits, you should probably keep more set aside

Where should you keep this money? It needs to be instantly accessible, and you might as well save tax on the interest if you can.  A Cash ISA might be a good idea.

Don't get to hung up on the interest rate – this is not an investment – but obviously worth looking for the best rate you can.

If you have an offset mortgage, you could put the money into an offset account; this will save you interest on your mortgage.

Remember the rules for accessing your emergency fund

• It's for emergencies only!
• Only dip in if both of you agree
• Only dip in having slept on it first

Finish your emergency fund and you'll be in a great position to start saving for longer terms.

2 – Spread your savings between long and short term goals

If you pile all your money against your short term goals, your long term ones will never be realised

For example, if your monthly budget for savings is £200 per month, and your holiday each year costs £2,500, you're never going to put money into your pension!

Instead, spreading the money across your goals gives you a better chance of meeting them all. I can't tell you how to prioritise here, but I would put more towards the longer term. This will mean that your short term goals may need to be less lofty, but it will be worth it in the long run.

3 – Use different investment strategies for different goals

The longer the term you are saving over, the more risk you can take. There is a clear link between risk and reward, but this is a subject for an upcoming podcast – too big to deal with here!

Also, there is evidence that the longer you hold an investment, the more its returns tend towards the average, making the ups and downs less pronounced over time.

The lesson from this?

• For short-term investments and your emergency fund, keep the money on deposit – Get the best rate you can, and use an instant-access ISA to save tax
• For longer term investments, consider real assets, true investments which have the chance of growing more quickly – More on investing basics in the next session

4 – The nearer you get to your goal, reduce your risk

This is called lifestyling, and reduces the impact of any market shocks on your money the nearer you get to goal. You wouldn't want your pension fund to drop by 20% just before you come to retire. So to avoid this you move money out of riskier assets and into cash and other low-risk things as you approach your target.

With pensions this can be done automatically, but with your investments you'll have to do this yourself most likely. In other words, you should keep your investments under review.

Nothing worse than an abandoned investment.

5 – Get started!

There's no time like the present to start saving.

I heard a story where someone asked a wise old lady: ‘When is the best time to plant an Oak Tree?'

She replied '50 years ago'

So he asked again: When is the second best time?

She answered: ‘Right now'

If you can stay in the habit zone you are in after paying off the debt, you'll do fine. Don't get complacent – remember the laser-focus

Financial freedom comes to those who stay the distance and don't get blown off course

Summary

Everything you need to KNOW:

1 – Savings goals should be divided into short, medium and long-term

2 – The longer the savings term, the great the impact of inflation

3 – Cash is not an investment

Everything you need to DO:

1 – Finish off your emergency fund

2 – Spread your savings budget between long and short term goals

3 – Use different investment strategies for different goals

4 – The nearer you get to your goal, reduce your risk

5 – Get started!

It's a great feeling to have money behind you, and having that full emergency fund is the ticket to sleeping at night and knowing you can cope with financial emergencies.

And then to start building towards something – it feels so grown up! Remember, we're not financial children anymore, we're taking control of our financial lives, and working t onwards a brighter future

Outro

That's it for this session of the MM podcast, I hope that was helpful.

Did I miss anything? Do you have any tips or tricks that work for you?

Do you have any questions?

Please leave any comments or questions in the comments section below

If you like what you hear on this podcast, please leave a rating or review on iTunes. It really helps others to hear about the show and to subscribe

On the day of recording, I have made it into the New and Noteworthy list of the Business Podcast section on iTunes – thanks to those who have reviewed me so far

Next time we'll be talking about Investing basics, including an interview with TV market commentator extraordinaire Justin Urquhart Stewart

If you have any questions about this, go to meaningfulmoney.tv/feedback and leave a voicemail

Thanks for listening – I'll talk to you next time