How to prioritize your savings

Dear Liz: I put 10% of my income into my 401(k) retirement account and my employer matches up to 6%. Should I also be saving another 10% in a regular savings account? I have $2,500 in regular savings right now.

Answer: You don’t say how old you are, how much you’ve saved for retirement already or what your other debts are. All those factors help determine where your savings should go.

You’re smart to be contributing to a 401(k) and getting the full company match. You can use an online retirement calculator, like the one at ChooseToSave.org, to see if you’re saving enough. If you’re not, you can boost your contributions.

If you’re on track for retirement, the next step is to pay off any toxic debt such as credit cards. (Toxic debt is any debt that carries high or variable rates and that erodes, rather than enhances, your wealth.) Once that’s paid off, you can focus on building up your emergency fund. In general, it’s smart to have at least three months’ worth of expenses in a savings account to be tapped in case of real emergency, such as a job loss.

Using cards as an emergency fund can hurt your scores

Dear Liz: Help! In the last year, my credit scores have dropped 30 points. I don’t know why except that my credit reports noted that I used 10 credit cards recently. (I’ve had many dire emergencies lately, but I paid off all my balances as usual.) I’m terrified of more drops. What can I do?

Answer: Build up your emergency fund.

Because you charged your emergencies, you used up more of your available credit. The more of your credit you use, the more negatively your scores tend to react. It doesn’t matter that you paid your balances off each month. What counts is the balances that your credit card issuers report to the credit bureaus, which are typically the balances on your latest statements.

Now, the good news is that your scores probably will recover as soon as you start charging less. But you should take this as a sign that credit cards are a poor substitute for savings. An emergency fund could help you survive life’s inevitable setbacks without having to run to your cards.

Finding advice on truly frugal living

Dear Liz: Most of the articles I read about saving money seem to be written for people who make a lot more than I do. I don’t eat out, drink lattes or buy clothes anywhere other than discount stores. Where are the articles for me?

Answer: All over the Internet. Start with one of the oldest frugal-living sites, the Dollar Stretcher, at www.stretcher.com. It’s filled with articles and tips for every budget, including the tightest. Mary Hunt’s Debt-Proof Living at www.debtproofliving.com is another good one to try. You also should check your local library for the book “Your Money or Your Life” by Joe Dominguez and Vicki Robin. It will open your eyes to the possibilities of financial freedom on any income.

Living paycheck to paycheck? Knock it off

Dear Liz: Like many Americans, I often must scramble to make ends meet between paychecks. I vigilantly monitor my account online, and when my balance is getting low, I curb my expenses as best I can.

Recently, I have had an overdraft experience that leaves me wondering about ethics and legalities. It was three days from payday and I had about $45 in my account.

I made four purchases under $10. Then a $54 automatic payment came through that I could not reschedule. One would think I would then be charged one overdraft fee, as all of the previous purchases made were within my available funds at the time.

I logged in today to find that the bank cleared the largest transaction first, which threw all other small transactions into overdraft. I was charged five overdraft fees because of this rearrangement of clearance order. I talked to a customer service manager who said that nothing could be done.

Essentially, it appears that the bank is manipulating transactions to capitalize on overdraft fees. This strikes me as unethical, and I wonder if I have any rights in this situation? Aside from getting a better job and making more money, what can I do to protect myself?

Answer: Of course the bank is manipulating your transactions to increase its fees. Most banks do. Lawmakers and regulators have questioned the practice, but so far it’s not illegal.

What you can do to protect yourself is to stop living paycheck to paycheck. That may sound like a flip answer when you’re on the financial edge, but you’ll never get ahead as long as a $54 overdraft can throw your finances into chaos.

Having just a $500 cushion in the bank can reduce not just bounced-check fees but also worry, sleeplessness and lost productivity at work, according to a savings review by Stephen Brobeck, executive director of the Consumer Federation of America.

How do you get a cushion? Try a “no spending” month. Limit your purchases to true essentials. Eat out of your cupboards instead of at restaurants. Entertain yourself at home or at the library. Most people can raise at least a couple hundred dollars this way, which you could supplement by having a yard sale and selling unneeded items online.

If you want more ideas, there are a wealth of frugal-living websites; start with one of the oldest, the Dollar Stretcher, at www.stretcher.com.

You also need to limit the bank’s ability to swamp you with “gotcha” fees.

First, sign up for true overdraft protection. Banks often automatically enroll you in an inferior substitute, called “bounce protection” or “courtesy overdraft.” These programs allow the banks to approve over-limit transactions and charge you $30 or more for each one.

True overdraft, by contrast, links your checking account to another of your own accounts: typically a savings account, line of credit or credit card. If your transaction exceeds your balance, the money is drawn from one of these accounts. You’ll pay an annual fee of around $50 and possibly a $10 per transaction fee, but the costs for making a mistake will be substantially lower than under bounce protection.

If the bank won’t approve you for true overdraft, ask it to stop approving over-limit transactions. If it won’t, take your business elsewhere.

Build savings or pay off debt?

Dear Liz: We have about $800 extra each month after paying bills, but we aren’t sure we’re doing the right thing with it. Should we pay down our adjustable-rate, maxed-out home equity line of credit? Or do we put it toward our savings, which has only $5,000 right now?
Answer: Before doing either, make sure you’re saving adequately for retirement. You may be tempted to cut back in this uncertain market, but the costs of retirement are so great that you need to start saving early and not stop if you want to have a sufficient nest egg. Your human resources department at work probably has tools to help you.
If you’re convinced you’re on track there and you don’t have any credit card debt, the next step normally would be paying down that home equity line. In today’s environment, however, you might find your lender lowering your limit as soon as you start to reduce your balance. Rather than freeing up credit that you could use again in an emergency, paying down your HELOC may actually reduce your overall financial flexibility.
This might not be an issue if you have tons of equity. If your current mortgage balance and your line of credit total less than 60% of your home’s current value, you may not need to worry about your lender reducing your credit limit.
If your loans total more than 60%, however, or if housing values are falling fast in your area, consider instead building up your savings.