Off on the Right Foot

Editor's note: This article appears in Kiplinger's special issue Success With Your Money.

One of the first things you'll learn about money when you're just starting out is that you always seem to need more of it. Especially on an entry-level salary, you'll look forward to the day when you're no longer living paycheck to paycheck.

But people who are older (and better paid) will tell you that it doesn't always work that way. On the contrary, the more you make, the more you tend to spend. The secret to getting your finances under control isn't necessarily to earn more (although that certainly helps) but to trick yourself into spending less and saving more of what you have.

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Tricks of the trade

While establishing her career as a comedian in New York City, Lynne Koplitz has come up with a whole repertoire of simple yet effective ways to manage her money. Before she got her showbiz break, she waited tables and earned a big chunk of her income in cash. As a result, she acquired habits that now help make her money last between gigs. To keep from overspending, Koplitz divides her expenses into categories and puts cash for each -- for clothes, for fun and even for her dog -- into an envelope.

Not only does she toss spare change into jars -- keeping quarters separate to use in parking meters -- but she also stashes dollar bills in a drawer. "Then you can grab a few singles to pay for takeout instead of breaking a bigger bill, which is the road to disaster," says Koplitz, who makes it a habit never to break a Benjamin.

When she was a waitress, Koplitz kept her first $50 in nightly tips as spending money. After that, she saved half of everything she made. She still has an automatic savings plan, only now she tells her accountants to stash 5% of her income in an account that's available if she needs it. "My mother always told me, 'That's your getaway money.' "

To control her credit-card debt, Koplitz once resorted to freezing her cards in a bowl of water. Now she carries just two cards -- one of them is American Express, which she must pay off each month -- and keeps the rest with her accountants. "If I want to use one, they ask me if I really want to spend the money."

To keep down entertainment costs, she takes guests out to breakfast rather than dinner "because it's cheaper and you get more." And when you're out with a group, never pay with a credit card and collect cash from everyone else, she advises. If you do, "you're probably going to come up short, and when you get the credit-card bill the cash will be gone."

Koplitz jots down her actual expenses in a notebook and tallies them at the end of each week to see if they're over or under her estimates. When she comes in under budget, she treats herself to a reward.

Tracking your spending might sound like work, but you don't have to do it forever; even one month is enough. Nor do you have to record every penny. An easy alternative is to use your monthly credit-card and debit-card statements to show where your money goes. Then you can plug the one or two areas where you're leaking cash and probably come up with an extra $20 or more per week in savings.

That's $1,000 a year -- and a grand is real money you can use to pay off debt, save for a car or take a trip to Hawaii. Once you know where your money's going, you're in great shape to take these five steps toward financial independence.

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Pay off your credit cards

If you graduated from college owing a balance on a credit card, you may be paying a heavy price for pizzas you've already eaten, clothes that have gone out of style and dates who are no longer in the picture. Time for drastic action:

• Stop using your credit cards (even if, like Koplitz, you have to put them on ice in the freezer). Henceforth, pay cash.
• Pay off your bills, using whatever strategy makes you feel as if you're making progress. Financially, it makes sense to tackle your most expensive debt first. But if you get a psychological lift by knocking off your smallest balance, go for it. You'll have an incentive to keep going.
• Don't carry a balance. Once you have your bills under control, you can pull out your card again to use as a convenience (and build up rewards points). But make up your mind to pay your bill in full each month. If you must carry a balance, have a plan for paying it off over a set number of months.

Write a clean credit history

If you've graduated without credit-card debt -- or without a credit card -- congratulations. Ironically, you may find that it's tougher to get a major credit card, such as MasterCard or Visa, after you leave school and have an income than when you were a penniless college student. Without parents in the wings to bail you out, you may be considered a riskier prospect.

But just because you don't have credit does not mean you can't get it. Go ahead, respond to the solicitations you get in the mail. If the bank or credit union where you have a checking or savings account issues credit cards, apply there. Or apply for a card from a retail or department store. Such cards are often easier to get, and you can build a credit history in six months to a year by making purchases and paying for them on time. Then apply again for a MasterCard or Visa.

One of the fastest ways to get credit is to apply for a secured card, which requires you to make a savings deposit equal to your credit line (for a listing of secured cards, go to www.cardweb.com or www.cardratings.org). After six months to a year, the issuer should upgrade you to unsecured status. That way, you can qualify for a lower interest rate and an increased credit limit without adding to the savings account.

Your credit history determines whether you get a card and what interest rate you'll pay. If you have a sneaking suspicion that your credit record isn't the best (or wonder if you even have one), go to www.annualcreditreport.com (or call 877-322-8228) and request a free copy. You're entitled to one free report per year from each of the three major credit bureaus—Equifax, Experian and TransUnion.

Based on your history at each credit bureau, you'll also have three credit scores, which reflect all the good (and bad) information in your credit reports.

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Plump your cash cushion

Your car breaks down. Your computer dies. You have an unexpected medical bill. Those are the rainy days for which, financial experts will tell you, you should have enough cash tucked away to cover three to six months' worth of living expenses. Right, you say. How am I going to get that kind of money?

The short answer is, you don't have to. Instead, aim for a less-daunting amount—say, one month's worth of expenses. You can beef up your reserve as your income rises. Have your bank make an automatic deposit into your savings account every payday so you don't even have to think about it.

Once you've saved the money, keep it where you can get your hands on it. The stock market, for example, is far too risky for money earmarked for an emergency. Your best options are a savings account at a bank or credit union, or a money-market fund. Money-market funds generally offer the best interest rates, but they may require a minimum deposit of $1,000 or more or restrict the number of checks you can write (look for a fund that suits your budget at www.imoneynet.com).

With short-term interest rates rising, it's easier to find banks, particularly on the Internet, that are offering competitive rates of 4% to 5% on garden-variety savings accounts. For monthly updates on top-yielding bank accounts and money-market funds nationwide, follow the listings in Kiplinger's Personal Finance magazine.

Open a retirement account

True, you won't be retiring for, oh, about 100 years. But saving is never easier than the day you start working, no matter how much your income goes up in the future. And thanks to the magic of compounding, the earlier you start, the greater your reward.

Consider two hypothetical savers, Jennifer and Scott. At age 25, Jennifer begins contributing $2,000 a year to an individual retirement account. She makes annual contributions for ten years. Then, with a home and children to claim her attention and her income, she stops, letting her money sit in the account.

Scott, on the other hand, spends his twenties, and his money, enjoying wine, women and wide-screen TVs. At age 35 he gets retirement religion. He begins to contribute $2,000 a year to an IRA and never stops. If Jennifer and Scott each earn an average annual return of 10% (the historical stock-market average), who will have more money at age 65?

Incredibly, Jennifer. Even though she stopped contributing after ten years and $20,000, her kitty will grow to $556,000. In contrast, Scott, who saved $60,000 in all, will have $329,000 -- a stunning illustration of how compound interest can work its magic if you start early.

If you have access at work to a 401(k) retirement plan -- or a 403(b), the nonprofit equivalent -- and your employer matches part of your contribution, jump at it. That's how Robert Goldberg kick-started his retirement savings. Goldberg, a health-care consultant in Philadelphia, contributes 6% of his income to his 401(k) -- money that comes off the top of his paycheck before he can spend it. As a bonus, Goldberg's employer matches 25% of his contribution -- and that's free money.

If your company doesn't offer a 401(k) or doesn't match your contribution, take matters into your own hands and open a Roth IRA -- a retirement account that's independent of your employer and goes with you from job to job. You can contribute as much as $4,000 in 2006. Goldberg automatically transfers $200 a month from his checking account to his Roth IRA. If you can afford only $1,000 a year, that's fine, too. A little bit goes a long way (remember Jennifer and Scott).

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Buy peace of mind

Once you've graduated from college, most insurance companies will drop you from your parents' health insurance. (Some may keep you on the plan until you're 25, however, so check with Mom and Dad.) Until you pick up coverage through a job, you may be tempted to go without insurance, banking on your good health.

But being in good health is one major reason to buy coverage now. It won't be expensive, and it will be there for you if you break your leg skiing or need an emergency appendectomy.

If you need insurance for a limited time -- say, before you start working or while you're between jobs -- consider buying a short-term health plan, which lasts from one to six months. If you're going to need insurance indefinitely -- say, because you are or expect to be self-employed -- it makes sense to buy an individual health policy that has a high deductible. You'll have to pay that much out of pocket before the insurance kicks in, but you'll be covered in case of that broken leg.

In return for the high deductible, your premiums will be considerably lower and more affordable. And if the deductible is at least $1,050 in 2006, you will be eligible to contribute pretax money to a health savings account, which you can use to pay for out-of-pocket medical bills. For help finding a policy, go to eHealthInsurance.com, or search for an insurance agent through the National Association of Health Underwriters at www.nahu.org.

One benefit of no longer being a teenager is that you don't have to pay top dollar for car insurance (although coverage is still pricey when you're in your early twenties). You can cut your premiums by raising your deductible to $1,000, improving your credit score (studies show that consumers with high scores tend to file fewer claims) and shopping for the best deal online at Insweb.com.

Don't think you can finance all of these strategies at once? Don't worry. Do as much as you can, setting priorities and doling out your money in small parcels. Or focus on the one thing that keeps you up at night, whether it's paying off your credit cards or building a savings account.

Once you've taken a step or two, you can breathe easier. Want to splurge on new shoes or that big-screen TV? Go right ahead. With your debt under control and your saving on autopilot, there's no reason to feel guilty.

Adapted from Kiplinger's Money Smart Women, by Janet Bodnar (Kaplan, $15.95).