Managing Your Hot-Water Heater:

Lower the temperature setting
Water-heater thermostats are often preset at the factory much higher than needed. It makes no sense to heat water to a temperature higher than that which we can use comfortably. If you have a calibrated dial, turn it back to 110 or 120 degrees and move up to higher settings if necessary. Although a setting of 140 degrees is usually recommended for dishwashers, a good detergent will give good results at lower temperatures.

The settings of some heaters read high, medium and low. Dial down to the next lower setting; adjust up or down as needed.

Maintenance
Twice a year (or every other month if you live in hard water area), drain a bucket of water from your hot water heater storage tank. This removes sediment which absorbs heat energy and causes you to use more fuel than you otherwise would.

Insulate the tank
Do this with a readymade kit sold in most hardware and discount stores. OR, for more savings at less cost, wrap with a fiberglass insulation blanket.

Safety warning
The Department of Energy says to use extreme care in insulating gas-fired heaters with blanket insulation and recommends the use of water heater insulation kits instead. The Consumer Services Administration cautions against putting blanket insulation on top of a gas-fired heater.

Tools needed
Gloves, tape measure, scissors or utility knife, board to serve as cutting surface and long piece of string or wire.
Materials needed
3-1/2 inches (R-11) or 5-1/2 inches (R-19) blanket-type insulation, kraft- or foil-backed duct tape.
Instructions
Distance around tank
Tank diameter
Cut length for 3-1/2 inch batt
Cut length for 5-1/2 inch batt

56 to 57 inches 18 inches 77 inches 92 inches
62 to 63 inches 20 inches 83 inches 98 inches
69 to 70 inches 22 inches 90 inches 105 inches
75 to 76 inches 24 inches 96 inches 111 inches

Use this chart to determine the length of batts you will need.
Buy the amount needed. You may not be able to buy part of a roll; see if you can interest a neighbor in sharing work and cost.
Cut a sample piece. Be sure you've cut the correct length. It should go completely around the water heater without lapping or being compressed. Now cut enough pieces of this length to fully cover the unit all around, and from top to bottom. Trim 1 inch off each end.
After cutting the required number of pieces, you're ready to put them around the water heater one at a time.
For electric heaters

With the paper or foil on the outside, stack one piece on top of the other and tape until the heater is enclosed. Install the bottom strip first. You may want to temporarily secure this with a long piece of string. Cut openings for the electrical connections, drain valve and temperature controls or mark the location of these on the floor or on the jacket itself.
Cut a round piece for the top. Cut as necessary to fit around pipes then tape in place.
For gas-fired heaters

The bottom strip should be at least 6 inches above the bottom of the heater. This allows combustion air to enter the burner properly.
Do not cover the top of the water heater at all
There must be provision to maintain the proper draft out of the flue.
Hot water pipes
Insulate the pipe between the water heater and the faucet. This helps keep the water in the pipe warm. Either pipe insulation or wraparound insulation is good for this. You can buy both at most hardware stores. Scraps left from wrapping your heater will give you more protection for less money. Wrap and secure with duct tape.

Wrap the cold water side too since heat is lost through thermosiphon action; 2 inches is minimum, 3 inches is better.

Insulation is especially needed where pipes run through unheated areas such as basements and crawl spaces. Insulate cold water pipes to reduce the chance of winter freeze-up.

Piping runs can be reduced by installing the water heater as close as possible to areas of greatest use, such as washers and baths.

Leaking water faucets are enormous wasters of energy and should be repaired as soon as possible.

Note
A hot water faucet that leaks one drop per second wastes 720 gallons of hot water in one month. In addition to the cost of the lost water is the cost of heating and pumping it.

Flow restrictors are small plug or washer-type inserts for your faucets and shower heads. You can cut the total water consumption (and the energy needed to heat and pump it) without sacrificing comfort.

References

Ohio Energy Service, "Water Heaters"
Efficient Energy Corporation, "Hot Water Heater Blankets Work!"
Consumer Action NOW, Women's Energy Tool Kit, Edison Electric Institute, Do-it-Yourself Projects