The recession has encouraged many Americans to take a more disciplined approach to savings and debt reduction. Personal savings as a percentage of disposable personal income (DPI), which dipped into negative territory in 2005, has run close to 5% in recent months. Total U.S. household debt as a percentage of DPI has also declined in the past two years.

Still, many investors are sabotaging their efforts without realizing it.

Nearly 28% of 401(k) plan participants had a loan outstanding on their 401(k) at the end of 2010, the highest level in the ten years that consulting firm Aon Hewitt has tracked such loans. And more than 29% of plan participants aren't contributing enough to meet their company match threshold.

"People spend and save what's left instead of saving and spending what's left," says financial advisor Steven Kaye, president of the American Economic Planning Group (AEPG) Inc., a wealth management firm in Warren, N.J.

Kaye strongly encourages clients to embrace the automatic savings of traditional 401(k) and tax-free Roth 401(k) plans-and to leave that money alone. "Plans to pay it back rarely work out because people aren't disciplined enough," he says. He'd also like to see more employers offer automatic 401(k) increases.

"The 401(k) is the first line of defense," advisor Patti Brennan, president of wealth management firm Key Financial Inc. in West Chester, Pa., tells clients. She really likes the Roth 401(k), especially for clients under age 55. "Yank the money right out [of your paycheck] so you can't see it or spend it," says Brennan.

Automatic deductions, no matter what they're used for, also enable investors to take advantage of dollar cost averaging-a concept she's a big believer in. Brennan and her husband used automatic deductions on their checking account to get an early start building college accounts for each of their four children. A 529 college savings plan is "almost a no-brainer because of tax benefits," she says.

She cautions against borrowing from a 401(k) account to pay off credit cards or other debt, largely because a 401(k) is a protected asset. Instead, she encourages buckling down and paying off debt through cash flow.

Brennan began working with a new client in his late 50s who was considering tapping into his $450,000 401(k) account to pay off $30,000 in credit card debt. Instead, she set up a disciplined program which cut his 401(k) contribution from 10% to 6% so he still received his employer match but had more money to pay off the debt. The 401(k) continued to grow and the client was debt-free in about 18 months.

Brennan and Kaye, both of whom are CFP licensees, place a lot of emphasis on helping clients understand their expenses.
At the top of Kaye's list is getting clients to distinguish between their wants and their needs. "People don't have a clue about their real expenses," he says. Even if they have a sense of the monthly and annual figures, they forget to factor in periodic big-ticket items like a new roof or new car.

Kaye and his colleagues ask all clients, regardless of their asset level, to think about how they want to live now, what would happen if they became disabled and what they would want to do in retirement. They project inflation rates of 3% for most expense items and 7% for education. They're also factoring in pending Medicare changes.

"Clients see their wish list and get sticker shock. It winds up being a terribly good learning experience," says Kaye, who also discusses survivor needs and uses Monte Carlo simulations to help clients see all possible scenarios.

Kaye is also a big advocate of converting traditional IRAs to Roth IRAs, a strategy that no longer faces income limits. His firm encourages small business owners to consider a "triple-decker" pension plan, which combines a 401(k) plan, a cash balance plan and a profit-sharing plan (PSP). By employing this trio, clients can often shelter more money for their families.

Advisor Gary Shor, vice president of financial and estate planning at AEPG, shares an example to illustrate the potential savings of a triple-decker strategy. Let's say a doctor earning $245,000 a year puts a total of $5,250 into a PSP for his two non-highly compensated employees and receives a PSP allocation of $49,000. Adding cash balance and safe harbor 401(k) plans for an added combined cost of $4,350 for his employees lets him allocate an additional $176,675 for himself. (Actual figures will vary based on specific plan data.)

One caveat: Since a cash balance plan is a real pension plan, "the owner is on the hook each year to fund it. The biggest hurdle is if someone is nervous about their cash flow," says Shor.

As for converting a traditional IRA to a Roth IRA, Shor notes that this is not an all-or-nothing proposition. Investors may be best off doing a partial conversion, something they should speak with their accountants about, he says.

Shor also shares with clients simple but effective savings strategies such as waiting 24 hours before purchasing large-ticket items, using eBay to purchase and sell slightly used items, saving money in qualified accounts that are hard to access, using cash whenever possible, borrowing tools from a neighbor and collecting loose change in a jar. He's collected $500 twice.

Kaye has observed that grandparents who haven't offered to contribute to college costs may be more than willing to do so if asked. With his encouragement, a client broached the subject with grandparents who are now generously footing the $50,000 a year college bill for two grandchildren. Unlimited tax-free education gifts are permitted as long as they're paid directly to the educational institution.

If someone plans to hold a vehicle for a number of years, it may be cheaper to lease and buy it out at the end of the lease after negotiating the residuals, says Kaye. He and a client with a Mercedes called the car maker at the end of the client's four-year lease. The client got the vehicle, which sported a $38,000 end-of-lease buyout purchase price, for $32,000.

Buying a car on New Year's Eve, when car dealers are trying to make their numbers for the year, is a strategy he's personally used a couple of times. That's when he got $20,000 off a demo Porsche Panamera for his wife. Vehicle buyers should also check to see if they're eligible for a Section 179 deduction and bonus depreciation, he says. These tax breaks can add up to thousands of dollars.

Kaye says investors should make sure they're using their flexible spending accounts efficiently. And biweekly mortgage payments are helping many AEPG clients save money on a few years of a 30-year mortgage or a couple of years on a 15-year mortgage.  

Brennan also has frequent conversations with clients about mortgages, especially when they're nearing a remaining balance of $50,000. If your money is earning just 1% in a bank account, paying off a 5% mortgage may be a good move if that bank account will still have an adequate balance for emergencies, she says.

Brennan believes in dividing savings into three pools: zero- to three-year money in safe and secure assets (including CDs, money market funds and sometimes short-term bonds), three- to six-year money mostly in debt instruments, and seven-plus-year money in equities. Staying three years ahead of cash flow needs, a strategy she has pursued in her portfolio since the high tech bubble burst, can help investors be prepared if there is another terrible bear market, she says.

She also suggests that clients complete the necessary paperwork now for future access to a home equity credit line should they face an emergency down the road such as a job loss.

Bonuses and commissions should be earmarked for particular savings goals such as retirement or other options, says Brennan. If you want to buy a second home, she suggests setting up a separate account for that purpose. "It's more tangible to wrap your head around," she says.

Finding the right savings and debt mix depends a lot on job security, notes Brennan. Someone with a more secure job may be able to accrue and maintain more debt than a person who works for a company that's laid many people off. Investors should also consider whether they can continue to keep servicing debt once they retire, she says.

Clients who don't have a good sense of where they're spending money may benefit from a free online money management program such as Mint.com, says Brennan. Clients can use it to set up a budget, receive weekly reports and get e-mail notifications if they exceed their spending limits in a particular area.

Although there are often no miracle cures for reducing debt, Brennan emphasizes to clients the influence of discipline, sacrifice and delayed gratification. And sometimes people just need to speak with a coach or another person who they can be accountable to, she says.

Brennan says that a financial planning firm she worked for early in her career required her to keep a personal budget to get a good understanding of cash flow and learn what it felt like to be a client. She recalls keeping track of McDonald's and 7-Eleven receipts. "Boy, is it an eye-opener," she says.