Savings rates start to drop

Last week, the Federal Reserve cut the Federal funds rate from 4.75% to 4.5%. The relationship between the federal funds rate and the rest of the economy is complex and long term. You won't see mortgage rates drop by 0.25% straight away, for example, because they depend more on long term interest rates.

But we are already seeing rates coming down on high-interest savings account. ING Direct has dropped their rate from 4.30% to 4.20%. Countrywide Bank are down from 5.50% to 5.35%. We will see if Emigrant Direct (currently 4.75%) and HSBC Direct (4.50%) follow suit.

Creating a budget

You might think you don't need a budget. You have money coming in, and you pay the bills as they arrive. Why budget? Well, without a budget you are like a driver on unfamiliar roads without a map. You are going along okay, but you don't have a plan for where you need to get to, and you don't know the best way to get there.

A budget can help you get to were you want to get to, such as retirement or enough money for a new car downpayment. A budget can help you adjust your spending, saving money here to put more savings towards the kids education. At the very least, a budget lets you know where you are today -- how much do you spend? Where could you make savings?

If the idea of creating a budget seems overwhelming, don't panic. Here is a quick start.

First, decide what tools to use. You can use pen and paper. Or a spreadsheet to simplify the sums. Or a budgetting web site (such as mint.com, Yodlee or Wesabe). Or use some fancial software (Microsot Money or Intuit Quicken). I think the spreadsheet approach works fine (I use Excel for my budget, and Microsoft Money to track account details).

Ok, so now write down (or type in) a list of the main areas where you spend money. To give you are start, here is a list of items in my budget:

• Car - insurance
• Car - gas
• Clothing
• Food - groceries
• Food - dining out
• Gifts
• Household - furniture, etc
• Household - insurance (home owners/renters)
• Household - mortgage payment or rent
• Household - property tax
• Health insurance
• Healthcare
• Leisure - books and magazines
• Leisure - other
• Pet
• Utilities - cable tv
• Utilities - electricity
• Utilities - gas
• Utilities - phones
• Utilities - water/sewage

You might have a few more - maybe student loan or car payments, daycare feeds, or whatever.

Now figure out how much you spend in each category. In my Excel spreadsheet, I have two columns: per month and per year. Some categories are per-year (property tax) while most are per-month. I then divide the per-year amounts by 12 to get an equivalent per-month amount. Add up all the per-month values can I get my monthly budget. This is how much I expect to spend (on average) each month.

Now compare to your income. If income (after tax) each month is less than the total from the previous step, you have a problem. You'll need to find ways to reduce your spending. This is where the budget becomes really useful -- look at the per-month numbers. Are you getting value for money for everything you are spending? Can you reduce spending on dining out, for example? Or switch to cheaper brand groceries? Drive less and save gas?

If your income per month is more than your expenditure, then congratulations! Now you get to decide what to do with the extra. This is a whole other topic, but good things to consider are retirement savings (IRA, Roth IRA, etc), or moving the extra money to a high-interest savings account. Or invest it in the stock market. Less practical, but more fun, you could save it towards a big purchase (a car or house downpayment).

In any case, you can use the budget to figure out how long you'll need to save for, or when you could retire (these calculations will require more information, such as expected rates of return, inflation, and so on).

Here is how I use my budget. I direct deposit my paycheck into my savings account. Then I transfer the "per-month" total into my checking account. I pay all my bills from the checking account, so this forces me to stay under budget. It gets a little more complex when a large yearly bill comes due (since I need to have enough to pay the bill) so I normally have a small additional "buffer" of money in my checking account. But overall this keeps my expenses under control and gives me predictable savings that I can use to plan my retirement savings and future big-ticket purchases.

Earn more money on your savings

Where do you put your savings? If you are like many people and move money from your bank's checking account to your bank's saving account, you are not getting your money's worth.

Despite the name, most bank "savings accounts" are terrible places to put savings. Consider Bank of America: their "Market Rate Savings" account sounds great. What could be better than market rate? But that account pays 0.20%. That's right, zero point two percent. Since inflation is around 3% today, this means your savings will be losing 2.8% of their value every year!

You should have your savings in an account that makes at least 3% a year, just to break even. There are many options, such as

• A high-interest savings account
• A high-interest term deposit (a "certificate of deposit")
• Invest in the stock market

All of these have a place, but for money that you might need in the short term, a high-interest savings account is the best bet. You should keep the minimum you need for day to day activity in your checking account, and move the rest from your checking account to a high-interest savings account.

The best rates tend to be offered online. At the moment, you can get 4.3% with ING Direct, 4.5% with HSBC Direct and 4.75% at Emigrant Direct. However the best deal seems to be Countrywide Bank, offering 5.5%. All of these banks are FDIC insured, which means that if they go bankcrupt (which is unlikely) you'll get all your money back up to $100,000 per bank.

Any of those make great choices for your savings. Since these are online accounts, they "link" to your checking account. You add money to the savings account by transfering it from the linked checking account into the savings account. To get money back, you do the reverse transfer.

Signing up for an online savings account is quite straightforward. You'll need details of your checking account (a check will give you all the information you need). If you want to get into the habit of saving regularly, ING Direct is the best choice because this is something they encourage.

But any account paying over 4% for your savings is better than most regular banks saving accounts. It is your money, don't let it waste away in a low interest account.