Which Is the Best Way to Save Money?

My problem lies in reconciling my gross habits with my net income.

~ Errol Flynn

Update: This article was included in the Festival of Frugality: Summer Edition posted at Where’s My Rolling Pin? Thanks!

I recently received a request from a doctoral student to fill out a short questionnaire on savings methods. The survey was directed at personal finance bloggers. Two different savings approaches were explained, and then respondents were asked which they would prefer, and to what degree. I wasn’t quite sure if I completely grasped the spirit of each approach, but I answered the questions to the best of my ability.

The two approaches proposed by the doctoral student are the circular savings method and the linear savings method. I’m going to outline both of them as explained by the author here, and I’d be

interested in your thoughts on them.

Circular Savings Method

This savings method involves setting aside a certain amount of money at regular intervals, such as each pay period. The idea is to focus on saving the amount that you want to save now, not next month, and not next year. “The future will be exactly like the present: if you save money now, you will save in the next pay period. If you don’t save money during the present pay cycle, it is likely you won’t save money in the next cycle. We want you to focus on your personal savings in the present”.

If you continue to save money each pay period, you will be able to look back at some point and realize that you’ve accumulated a nice nest egg. This method views life as consisting of “many small and large cycles”. I understood the focus of this approach to be saving regularly to the best of your ability given your current circumstances rather than looking very far into the future and trying to come up with an end goal to achieve.

Linear Savings Method

This method views life as composed of “separate time compartments such as the past, present, and future. We want you to think of the personal savings task as part of such a linear progress. Make your saving task a planned one: just focus on the total amount of your savings goal for the future. Think about discrete savings tasks and do each task one at a time. Do not think about what you have or have not saved in the past.”

If you save money now, you’ll be in a much better position in the future. But “saving is not an action that is the end goal, but rather a means to the more important goal of attaining something which lies in the future, such as your retirement or a better life”.

A Balanced Approach

When I really thought about it, I had to conclude that an approach that incorporates both a linear and circular component would probably serve most people well. The survey asked the following question: “If you had to suggest one of these approaches to your blog’s readers, which one would you choose and why?” My answer was as follows:

I can see some merit in both approaches, but I would likely choose the circular method if I had to choose only one. This method makes saving a habit. I think you might be able to use the two in conjunction if you used the linear method to choose a circular savings amount based on your current resources and time horizon.

For example: You could use the linear method to set short and long term savings targets, and examine areas in which to cut spending, or earn more income in order to achieve those big picture targets. Setting a regular savings amount is key to achieving those goals. This savings amount can be adjusted periodically as your life unfolds, but always saving something is imperative.

Another question posed was: “In your opinion, what are the reasons people use a linear or circular savings method for their savings?” Here’s how I answered that one:

Circular savers understand that regular saving is a good way to maintain a disciplined approach to achieving their savings goals. Linear savers are probably more concerned with the big picture and end goals and less concerned with the details of getting there.

It seems like the linear approach would work better for those who are extremely self-disciplined and are able to keep a close eye on the big picture and the end goals. Unfortunately, many of us do not fit this profile and need regular, circular savings to help us enforce that discipline on ourselves. We tend to live in the present and can sometimes forget about or ignore the future consequences of our present actions.

Perhaps one of the reasons we, as a society, have not been saving enough is that we are using the linear saving strategy, but not carrying out the discrete savings tasks necessary to achieve our goals. Including a circular component to our savings strategy would go a long way toward increasing the overall savings rate.

I like to think of myself as pretty well-disciplined. As such, my approach tends to be more linear. But that hasn’t served us all that well over the past couple of tumultuous years as we haven’t been saving regularly. In the past, our income was extremely variable with a modest regular income punctuated by some fairly consistent and sometimes substantial commission windfalls.

As such, I would plan our savings based on this type of linear progression. We’ve managed to save a decent amount without contributing monthly. Still, I’m reconsidering that approach based on some recent changes. I’d like to add a circular savings component to our financial plans in order to make saving a real habit that we can maintain through good times and bad. I’ll have more on that in the next quarterly update, scheduled for the end of June.

What do you think of these two savings methods? Would you lean toward one more than the other, or would you prefer a combination approach?