Getting started saving money can seem hard, especially if you don’t know where to start. Knowing how much to save and through what savings vehicle to do it are tough questions with several different answers. It’s also important to know why are you are saving. The biggest reason to start saving is so you are standing on a strong financial foundation regardless of your situation.
Consider an emergency fund. Before you do much of anything (such as going on vacations, eating out, buying new clothes, paying for a gym membership, investing, starting a business, etc.), you should have a savings account for emergencies (i.e. an emergency fund). Experts recommend anywhere from 3 months to 12 months of living expenses saved in an emergency fund. An emergency fund will give you a sense of security and margin in your life so you’re not worried and stressed about paying for things you need. When something goes wrong and you have an emergency fund, you may be mad or frustrated, but you won’t be scared. Being able to pay for things in a pinch will make you feel secure and strong (and who doesn’t want that?).
Aside from an emergency fund, there are many other savings accounts that can help you meet your goals. Below are tips on how much to save, what to save for, and different savings vehicles to save your money in.
How Much to Save
A great way to start saving money is to allocate a set amount of money from every paycheck into savings. If you set up direct deposit or an automatic online transfer, you will pay yourself first. This way, you build savings no matter what. If you wait until the end of the pay period or month, you’ll likely be out of money. The key to success with saving money is doing it little by little. If you make a habit of saving every paycheck you are setting yourself up for a strong financial foundation (the habit of saving is more important than the amount). Here are a few ideas to help you get started.
- The 50-20-30 rule. Under this rule, 50% of you money goes toward essentials (housing, food), 20% goes toward financial payments (savings, retirement, and debt payments), and 30% goes toward lifestyle (such as cable, dining out). Under this rule, you divide the 20% for financial payments between your retirement savings, emergency fund savings, debt payments, and any other savings accounts you want (education, vacation, etc.). Dividing up the 20% varies by person, but generally, retirement, emergency savings, and high interest debt payments are a top priority.
- Allocate 10% of your take home pay toward savings every month until you have a 6-8 month emergency fund. After that, start another account (retirement and/or other savings accounts) and divide that 10% toward these new accounts, continuing to save based on what you want to accomplish.
- Put 5% of your take home pay toward an emergency fund, 5% toward retirement, 5% toward anything else you want to save for(vacation, education, etc.).
- Save whatever you can every month. If you’re just starting out, saving 20% may seem like a lot. If you have other obligations that make this impossible for you, put whatever you can into savings every month. Then, when you can afford more, be sure to increase your contribution amount. And again, always pay yourself first (not at the end of the month).
What To Save For
Experts vary on the amount and types of savings accounts you should have. However, you absolutely need an emergency fund. Aside from that, your personal priorities trump (education, retirement, etc.). Below are examples of common savings accounts.
- Emergency Fund
Experts suggest saving for at least 3 months and up to 12 months of an emergency fund. Multiply your expenses by however many months you’re saving for and that is the number you should have saved. So, if you bring home $4,000 per month and your expenses are $3,000 per month, then your emergency fund should have be a minimum of $9,000 and up to $36,000 in it. Having an emergency fund will protect you when unexpected things happen. Only after you have this money saved should you do things like buy a home or go on vacations. This is your backbone. Don’t touch it; just leave it alone. Having this buffer and “breathing room” will give you confidence, power, and security as you make financial decisions in the future.
- Big Purchase Savings
Aside from an emergency fund, think about opening a savings account for big purchases, such as a car or a down payment on a house. This way you’ll be prepared to make big purchases without having to scramble.
- Vacation Savings
No more charging your vacations (or going on vacations because you “deserve it”)! Start saving for vacations ahead of time. It doesn’t make sense to ever go into credit card debt for a vacation.
- Education Account (if applicable)
If you want to go back to school or have young children, consider opening a 529 plan or other education vehicle to save for education expenses. You don’t have to take out student loans for school (don’t make the mistake I made).
Types of Savings Vehicles
There are three types of accounts that are good places to save money when you are building an emergency fund. These three places keep your money remains liquid (i.e. easily accessible if and when you need it). These three accounts are: 1) savings account, 2) money market account, and 3) certificates of deposit (CDs). (Real estate is not liquid, so if you have equity in your home, you should not consider that as savings.)
- Savings account
A savings account is an account at a bank or credit union with an interest rate that is higher than a checking account, but that which is easily accessible for you to withdraw your money. Banks usually limit the amount of withdraws to 5 per month for a savings account.
- Money market account
A money market account is a type of savings account offered by banks and credit unions. The difference between a money market account and a savings account is that a money market account pays higher interest rates, has higher balance requirements (up to $10,000), and allows you to write a limited number of checks per month. You can withdraw your money from a money market account, but you are limited to a specific number of monthly withdrawals.
- Note: do not confuse a money market account with a money market fund, which is an investment fund that is often opened at a brokerage firm or mutual fund company.
- Certificates of deposit
A CD is an investment tool issued by banks that is very low risk and usually low return. The interest rate is determined ahead of time, so you know what you’re getting back. While CDs are considered liquid savings, there may be penalties if you withdraw your money before the CD has matured (whatever the specific time period is that you agreed to). However, it’s still available in the event of an emergency.
A Final Note!
Regardless of what you save or how you save, make sure you are saving something. The habit of saving is more important than the amount. Getting ahead and standing on a strong financial foundation requires having and maintaining strong savings accounts, so if you haven’t started saving yet, now is the perfect time.