How to spend money wisely: a guide for the new year

With the new year just beginning, it’s a great time to reflect on our money management habits and consider how we can learn to spend money wisely going into 2024. I’m guessing I’m not alone in feeling like my monthly budget takes a hit around the holidays. Plus, many of us plan our short- and long-term goals around the new year. All of this highlights that January is the perfect time of year to think about our saving and spending.

So how do we spend money wisely? In this post, I’ll go over transformative money habits that, when followed, lead to greater financial security and empower you to achieve your financial goals.

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Spend Money Wisely by Deciding on Your Financial Goals

The first step for making wise financial decisions is to set savings goals. If we don’t have a vision that guides our financial planning, it’s very easy to spend extra money on impulse purchases. It’s also not very exciting to save money when we don’t know what we’re saving for in the first place.

So take some time to reflect on your short-term goals (less than 5 years away) and your long-term goals (5+ years away). Short-term goals can include things like a dream vacation, an upcoming wedding, or even buying a designer purse you’ve wanted for years. Long-term goals might include saving for a down payment on a house, your kids’ college funds, or retirement.

As you list out your goals, you may struggle with what to prioritize. Reflecting on your personal values can help you discern truly meaningful goals for you. For example, if you value freedom and adventure, you might prioritize saving for trips over saving for a down payment on a home. If you have lots of goals, consider choosing a few that are particularly meaningful and that you can realistically accomplish. Once you have the right financial goals in mind, you can establish the good habits to make them a reality.

Timeline Your Financial Goals

You may also find it valuable to timeline out your goals. Former financial advisor and host of the financial podcast Stacking Benjamins highly recommends this step. Ask yourself, how many months or years away is my goal? What’s the total cost of that goal? And how much would I have to save monthly to reach that goal in time?

Timelining out your goals can help them seem much more realistic, give you a concrete long-term savings plan, and help clarify whether your timeline is realistic or whether you need to delay your goal in order to save enough.

Once you have a sense of your financial goals, it is much easier to spend your money wisely because you’ll more easily recognize that the cost of another pair of jeans is not just the sticker price, it’s also the additional time it will take you to save for your dreams.

Build An Emergency Fund

One of the most important and neglected savings goals is having an emergency fund. I know an emergency fund isn’t the most exciting savings goal ever. However, in terms of order of importance, an emergency fund should be your first savings priority.

The reason is that unforeseen circumstances like an injury or car repair can totally derail all your financial plans. If you haven’t set aside money for these emergencies, you may have to rely on credit cards as well. No one wants to be saddled with high-interest payments after shelling out a bunch of money for an emergency.

A good rule of thumb is to save 3 months of bare-bones living expenses in your emergency fund. If that seems impossible, try saving $500. If you reach $500, try for $1,000. Saving $500 (or more) is a great way of protecting yourself so that the next time an emergency inevitably happens, you’re prepared.

Set Up Direct Deposit to Make Saving Automatic

For most people, the hardest thing about saving is reliably doing it each month. Saving is difficult to prioritize when we have a million different things to spend money on. Indeed, it’s hard to focus on long-term goals that seem far in the future when we can go out for drinks with our friends now. To turn saving into a good monetary habit, make it automatic.

Most service providers allow you to directly deposit a percentage or amount of your paycheck each month (or at whatever time interval) into a savings or investment account. If you’re nervous about doing this, try setting up a small automatic deposit like $25 per month into a savings account. As you get comfortable, you can add more to your automatic savings. You might be surprised at how quickly your savings add up and how little you miss that money!

Develop a Basic Budget to Help Spend Money Wisely

Once you have your financial goals in place, you can work on creating a budget. A budget is an incredibly helpful way of developing wise spending habits. It provides guideposts for how much you need to spend and save each month to meet your goals. It is also a useful way to identify places where you can cut back on frivolous spending and save money so you can achieve your goals faster. And a budget can even show when you need to ask for a raise or look for a new job.

Identify Your Income

When creating a budget or spending plan, your first step is identifying your after-tax income. Make sure to include all the income you get from various sources like W-2 jobs, self-employment, interest payments, etc. This first step will help you see how much money you have to work with. It’s shocking how few people truly know their monthly income.

Track Your Necessary Expenses

Next, calculate how much you spend monthly on basic needs like food (excluding restaurants and take-out), rent or mortgage payments, insurance, and utilities. Most of us don’t have a good idea of this amount unless we’ve been tracking our spending habits on our own or with budgeting apps. So look back at your past few months of credit card and bank statements to help get a sense of your spending. Financial experts recommend that you spend 50-60% of your post-tax income on necessities.

Build In Your Savings Goals

Ideally, your next step is to build your savings goals and debt repayments into your budget. Aside from covering your basic daily needs, your savings goals and debt repayments should be the central part of your budget. Many people treat their savings goals as something they contribute to when they have enough money left over. But that’s not a good option if you want to actually achieve your goals and pay off debt. Aim for this category to represent 20% of your your budget.

Track Your Non-Necessary Expenses

Finally, calculate how much you spend on average per month on discretionary spending. This includes things like eating out, vacations, going to the movies, and that impulse buy at Target. Look back at your last few months of bank and credit card statements to get a sense of your non-necessary monthly expenses. Financial advisors recommend that you keep your non-necessary purchases to 20-30% of your monthly income.

Identify Places Where You Do Not Spend Money Wisely

If your monthly income does not cover your necessary and non-necessary spending and your savings goals, you have a few options. First, evaluate whether you are spending far outside the recommended percentages of spending for necessary expenses (50-60%) and non-necessary expenses (20-30%). If so, consider the best way to reduce that spending.

The three biggest expenses for most people are housing, food, and transportation. Consequently, the best way to cut expenses is generally to reduce spending in these areas by downsizing, meal planning, moving to a lower-cost area, using public transportation, etc.

If your non-necessary spending or credit card debt payments are super high, it’s a good idea to get that spending under control. Focusing on your savings goals can help. Some people also find budgeting apps useful for providing real-time insights into how much they are spending. You might even consider talking to a therapist if you really struggle with overspending.

Finally, if you do not overspend or have considerable debt payments, you likely need to increase your income. Consider asking for a promotion or raise. If that is not an option, you might look for a new job or side hustle.

Develop a Budget That Will Allow You To Spend Money Wisely

Once you have a sense of how much you spend now and how much you need to spend in the future to meet your goals, you can work on developing your budget. Financial expert Ramit Sethi calls it your conscious spending plan (CSP). Your budget or CSP includes your target amounts to spend for your necessities, non-necessities, savings, and debt payments. Your goal is to keep your spending to these targets each month.

Of course, it’s difficult to consistently evaluate your spending in this manner. You can use budgeting apps, your own spreadsheets, or automatic deposits to help you. With the first method, budgeting apps like Rocket Money and YNAB will automatically track your spending and let you set targets for how much you want to spend and save each month. For the most part, these are pretty foolproof ways of staying on track.

If you want more control, you can track your saving and spending yourself. I love Nerdwallet’s budgeting spreadsheets for doing so.

Or you can have multiple checking and savings accounts for necessary spending, non-necessary spending, and savings goals. Simply automatically deposit a percentage of your paycheck into each account based on your budget.

For example, you might deposit 50% of your paycheck into an account for necessary spending, 30% into one for non-necessary spending, and 20% into savings and investment accounts. You’ll then have a clear sense of how much you’ve spent and saved in each category based on what’s left in the particular account.

Use Credit Cards Wisely (or Not At All)

If you have debt payments, you know they can quickly derail your budgeting strategy. Credit card payments are the worst of these. Late payments and high credit card usage hurt your credit score and represent lost money. You don’t get any benefit from having to pay interest. Plus, credit cards’ late fees and interest rates are much higher than for most other kinds of debt like your house or car payment.

For those with credit card debt, focus on paying down those cards. The interest you pay on credit cards will be much higher than any interest you earn on savings or investments. Consequently, in many situations, people benefit more from paying off credit cards than saving that money.

You may also want to focus on paying with debit cards until you get a better handle on your spending. If you earn credit card benefits, you might think this sounds like a costly strategy. However, those credit card benefits are more than eaten up by your interest payments. After all, how do you think they offer benefits in the first place? It’s like spending $1 to get a penny back.

If you prefer to keep using your credit cards, you can set up alerts to let you know when you have reached a certain amount on your credit card so you can curb that spending. You can also look into the avalanche and snowball methods for paying down debt. Responsibly using credit cards is one of the most important ways you can learn to spend money wisely and within your means.

Save Your Money in the Right Place

It may seem strange that part of developing wise spending habits is knowing where to save your money. However, saving your money in the right places is an easy way to earn money to better support your saving and spending.

For your short-term savings goals (goals that are happening within the next 5 years), consider putting your money into a high-yield savings account (HYSA). As of the time of this writing, the best HYSAs are offering 4-5% interest rates on their savings accounts. This is more than 33-500x more than the interest rates at conventional banks like Wells Fargo, Bank of America, and US Bank. This can translate into hundreds of dollars earned in interest each year.

Plus, with the exception of a couple-day transfer period, you can easily transfer the money in and out of your HYSA account as needed, similar to how you would with a traditional savings account.For long-term goals that are 5+ years away, you might consider saving your money in investment accounts. Look for financial products that are well diversified, have low fees, and good historical returns. For example, index funds and ETFs based on the S&P500 from a financial institution like Vanguard check all these boxes. Investment advice is beyond the scope of this piece. However, you can find advice for beginners on investing at Department of Adulting.

Summary of How to Spend Money Wisely

To sum up, if you want to spend your money wisely, the most important steps you can take are:

1. Outline your financial goals. Make sure to include an emergency fund as one of your savings goals.
2. Track your spending and income over the past few months. If your income does not cover your spending on necessary and non-necessary purchases and your savings goals, consider ways to cut your spending or increase your income. Likewise, if you are spending more than 50-60% of your take-home income on necessary purchases or more than 20-30% of your income on non-necessary purchases, consider cutting those.
3. Develop a budget that can help you stay on track with these spending targets. Your budget should outline how much you plan to spend each month on necessary and non-necessary purchases and how much you plan to save each month. Budgeting apps, spreadsheets, and automatic deposits can help you stay on track.
4. Limit credit card usage if you have considerable credit card debt. Make a plan to pay off high-interest debt as soon as you can.
5. Save your money in the right places so that you can earn passive income.

Following these steps can help you spend your money wisely and build strong financial habits. These steps may seem simple, but they are the building blocks for financial independence. I hope they allow you to feel greater control over your own finances and go into the New Year feeling confident.

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How do you ensure you spend your money wisely? What is your favorite tip or advice to manage your money? Share your money secrets below in the comments!