Saving money works as an insurance policy against unexpected financial situations and it helps fund your retirement. Building your savings can also have other benefits you may not have considered.
With money saved away, you have psychological power over your career because you don't need your job to pay next month's bills which may give you the ability to walk away from a job that makes you unhappy or even go back to school to get a degree. You also have the freedom to spend more money today to save money in the long run. You can buy higher-quality items that last longer, buy items in bulk when they're on sale, or invest in more energy efficient products that reduce your utility bills.
Unfortunately, many people simply aren't saving enough. Just 40% of adults in the United States could pay for a $1,000 unexpected expense with their savings and about half of Americans are at risk of a lower standard of living when they retire.
You probably already know you should be saving more and have been telling yourself for some time that you need to change your financial habits. Ready to take control of your money and start building your own financial independence? Here's a complete guide to not only budgeting but also saving money wisely for your future.
You've made the decision to take control of your finances and finally start saving money. Building a savings nest isn't just important for your long-term goals, such as retirement or buying a house, it's also crucial to break the cycle of living paycheck-to-paycheck and achieving real financial success.
Saving more money sounds like a simple concept, but where do you start? How much money should you save? What about investing? Here's what you should know to get started.
There's no hard rule on how much you should be saving each week or each month. It depends not only on your expenses but also your short-term and long-term goals. Still, there are a few strategies you can use to reach your savings goals.
No matter which approach you use, think of saving money as paying yourself first. Your savings deposit should be just another expense on your budget, just like the rent and insurance premiums.
One of the most basic savings plans is setting aside a specific percentage of your income until you reach your savings goals. A good rule of thumb is 10% or 20% of your income which you can set to transfer automatically from your checking to savings account when you get paid.
If you aren't comfortable with the idea of calculating a percentage of your income, choose a dollar amount you can comfortably save each month. It may only be $50 or it may be several hundred. It doesn't matter if you start with a small amount; the key is to start saving something.
This basic budgeting model means 50% of your income goes toward fixed expenses like rent, car payments, and utilities; 30% goes toward debt and discretionary spending; and 20% goes toward all savings and financial goals, including retirement or an emergency fund.
You probably don't just have one goal for saving money. If you have very little saved right now, you should be thinking of an emergency fund but also retirement. You may also want to save for a specific goal such as a down payment for a home or a new car.
To give you motivation, you may find it helpful to have separate savings accounts for different goals.
So, how much of your monthly savings should go toward each savings goal? Here are some guidelines:
You're diligently putting money aside in your savings account, but your money isn't earning a very good return. You know you should leave some savings as liquid cash for an emergency, but at what point should you start investing the money you've saved to potentially get a much better return?
It's always a good idea to have a sufficient amount saved for an emergency before you start investing. Aim for a liquid emergency fund of 6 months' of expenses before you turn to investments.
Think of your savings as the foundation of your financial situation. You need the savings to fuel investments but, if things take a turn for the worse, you may be forced to sell investments at a loss without your savings to fall back on.
It's a common conundrum: should you start building your savings first or focus on paying down costly debt?
Each option has its advantages. By putting aside some money first, you'll have a cushion in case of an unexpected expense and you can breathe a bit easier. By paying down debt first, you can save more money that you're paying in finance charges.
As a general rule, it's usually best to pay off debt instead of adding to your emergency fund or retirement until you have the debt under control.
Paying off your debt first can help you resolve your ongoing financial problems, free up more money to save, and help you learn to better manage your money.
Paying off debt also comes with a great guaranteed return that's probably much higher than you can get from any type of savings account or even more than you'd typically earn in the stock market.
Not all debt should be your priority over saving money, though. Low-interest debt like a mortgage or a student loan doesn't need to be paid off aggressively. High-interest credit card debt, though, should definitely be your focus.
There are some exceptions. It may be better to make saving money your biggest priority if:
The best way to make sure you're reaching your savings goals and actually paying yourself first is by automating your savings. Saving money shouldn't have to be something you think about. If you save it for the end of the month, you may end up spending more than you want to and have less to put toward your savings account.
There are several ways to automate your savings:
When you commit to saving money, one of the first decisions you need to make is what type of account you will use to safekeep your money. There are many types of savings accounts ranging from basic deposit accounts to certificates of deposit (CDs) and money market accounts.
Here's how each one works.
Also known as just a savings account, this is the most basic option for saving money but making sure it's still easy to access. You can usually open a deposit account with your bank or credit union with a very low minimum deposit to avoid monthly fees. You can transfer money to and from a checking account or use the account to pay bills, but you will be limited to just 6 monthly transactions (not counting ATM withdrawals and in-person transactions).
A deposit savings account usually has a very low interest rate rarely exceeding 2% APY (annual percentage yield). On the plus side, you can easily access your money.
A deposit savings account is best for:
A money market account or MMA works like a deposit account as your deposits will earn interest, but these accounts usually require a larger deposit to avoid fees. A money market account doesn't just offer a higher APY; it also allows you to write checks against your balance.
A money market account is best for:
A CD is different than a deposit account because it has low liquidity. When you open a CD, you commit to leave your money in the account for a specific term which can be anywhere from 1 month to 10 years. The longer the term, the higher the interest rate.
If you withdraw money from your CD before it matures, you will face fees. That's why it's not a good idea to use a CD for an emergency fund.
There are many types of CDs:
Traditional CDs with a maturity date and a penalty for early withdrawal
Liquid CDs which allow you to withdraw money without a penalty in exchange for a lower rate
Jumbo CDs which usually require a deposit of $100,000 or more for the best rates
Callable CDs which give the bank the right to invalidate the agreement after a certain amount of time, although a higher interest rate is offered in exchange.
A certificate of deposit is best for:
Health savings accounts (HSAs) and flexible spending accounts (FSAs) are tax-advantaged savings accounts designed to cover medical expenses.
An HSA can be opened if you have a high-deductible insurance plan with an annual deductible of at least $2,700 for a family or $1,350 for an individual. The money you put into an HSA isn't subject to income taxes and the money can grow tax-free. It can even be withdrawn tax-free as long as it's used to pay for eligible medical expenses. You can also choose to invest your funds.
An FSA is similar but it's obtained through an employer. Because the employer owns the account, you lose the account and remaining balance if you leave your employer, but many employers contribute some annual amount. With an FSA, you can contribute pre-tax money directly from your paycheck to help pay for medical expenses.
An important distinction is an HSA isn't attached to your employer.
An interesting application of the health savings account is it can be used for retirement savings. With an HSA, you can contribute pre-tax money and withdraw it tax-free, unlike other retirement savings accounts. You can contribute to an HSA until you're 65 and invest the money, then use it to pay for medical expenses as needed, including in retirement.
A 529 plan is a very specific type of savings account that helps you save for future education costs. 529 plans can be a bit confusing because they come in two forms:
Prepaid tuition plans that let you pre-pay the cost of a public in-state college education.
College savings plans work like a Roth IRA, investing the after-tax money you contribute in mutual funds with different investment options.
A 529 plan may be sponsored by the state or an educational institution. Nearly every state offers a 529 plan, each with different contribution rules, fees, and potential tax benefits.
529 contributions are always made with after-tax money and the earnings will accumulate tax-deferred. You can make tax-free qualified distributions to pay for college expenses. In most states, contributions also qualify for a state income tax credit or deduction.
If you open a 529 plan for a child, anyone can contribute money. The plan can be used to pay for a child's undergraduate school, graduate school, law school, or medical school, or the beneficiary can be changed to another qualifying family member if the child does not go to college.
A 401(k) is a special type of qualified retirement plan that's offered by employers to employees. With a 401(k), you can contribute money from your paycheck and get a tax break either when you contribute the money or when you withdraw it during retirement. With pre-tax contributions, saving money for retirement is easier and your contributions can reduce your income taxes. The money in your 401(k) is invested in funds that you choose.
Not everyone can access a 401(k). This type of retirement plan is only available if your employer offers one. According to the Pew Charitable Trusts, 35% of people in the private sector aren't working for a company that offers a 401(k). About 41% of millennials don't have access to a 401(k) plan.
A 401(k) is a crucial part of retirement savings, if it's available to you, because many employers offer a match on a percentage of what you save. Employer matches are one of the greatest perks of a 401(k) because they essentially give you free money to stretch your savings even further. Most employers match a percentage of your contributions, such as 50% or 100%, up to a certain percentage of your total salary, such as 5% of your annual salary.
With an employer match, not only are you putting even more money in your retirement plan, you're also essentially increasing your salary by 3% to 6% or so.
An IRA is another type of retirement savings account that lets you save for retirement on a tax-deferred basis or with tax-free growth. There are several types of IRAs, all of which offer tax benefits to help you grow your retirement savings faster. As a general rule, you or a spouse must earn income to be able to contribute to an IRA. You must also meet income guidelines; if you make too much money, you can't benefit from an IRA.
An IRA is available to you even if you can't contribute to a 401(k), but you can contribute to both an IRA and a 401(k) if you have both.
The right type of IRA will depend on your current income and your predicted financial situation at retirement. IRA options include:
If your income exceeds IRA limits, you can still contribute through a "backdoor IRA" which means opening a traditional IRA and converting it to a Roth IRA.
The key to saving money is knowing where your money is going every month and plugging the holes. Without an effective budget, you may spend more than you realize with your money slowly trickling away to drinks with friends, movie rentals, magazines at the checkout, and other frivolous but small purchases.
Budgeting doesn't need to be a time-consuming or painful experience. People who budget are actually less likely to report financial stress than people who spend without much thought.
Think of budgeting as giving your money an assignment with clear spending limits to help you use your money not just responsibly but efficiently to do the things that matter to you.
Here's how to get started with a budget you can actually live on.
The first step of budgeting is knowing what you spend now and where your money goes. A budget that isn't realistic is doomed to fail.
Track your spending for at least a month with one of these options:
Don't forget there are plenty of expenses that only come up quarterly or annually. Planning for these expenses means you won't have to borrow money for the holidays or car registration.
Common irregular expenses include:
Because you want to budget to make the most efficient use of your income, you need to know how much you make. Add up your income from all sources like wages, a business, investments, and side jobs.
Next, create financial goals to help you budget for success. You may have short-term or long-term goals but you should make them as specific as possible and add a deadline. You may want to buy a new car, pay off debt, save for retirement, or put aside money for a big trip.
Now that you know how much you make and what you spend, determine how much you need to save to reach your goals. As a general rule, you should be saving at least 10-20% of your income but this may be split among multiple financial goals.
With all of this work out of the way, you can make the right budget for your spending, lifestyle, and goals. Here are a few options:
With this approach, 50% of your income will go toward fixed expenses and needs (rent, food, utilities, etc), 30% will go toward discretionary spending and debt, and 20% will go toward saving and financial goals.
With this approach, your goal is to have every dollar you make assigned to something, whether it's savings, debt repayment, fixed needs, or discretionary spending. This is a restrictive budgeting option and requires some practice.
This style of budgeting focuses on optimizing your budget to your priorities and the things that make you happy. Start by budgeting for the most important bills and financial goals then consider what makes you happy. This may be attending music festivals, giving to charity, or something else. Prioritize these types of expenses and stop spending on other things that don't matter.
Every month, give your budget a check-in to see what's working and what isn't. Do you tend to overspend in a certain category? Have any expenses popped up that you didn't budget for? Did you come into money that can be put toward your financial goals? When something doesn't work, it's time to look into where you can cut back expenses or try a different budgeting method.
Mint is our favorite budgeting tool because it's free, simple, and allows you to track not only your spending but your savings, investments, bills, and even your credit in one place.
Mint also makes it really easy to set up a realistic budget that you can check in real-time on the go.
Once you set up your Mint account, start by linking all of your accounts, including your checking, savings, investment, and credit card accounts. It's also a good idea to set up your bills in the Bill Pay Tracker to make sure everything's paid on time.
Once your transactions are imported, you can start making adjustments and make sure everything's categorized correctly. A budget will be generated automatically but it will probably need some tweaking, especially if you're ready to optimize your spending.
Follow these simple steps to set up your Mint budget.
Curious how your budget stacks up against the typical American? Here's what the average household with net spending of $60,000 and gross income of $73,500 spends.
Want to make even better use of your money and start putting more toward savings and financial goals? It's time to optimize your budget to cut back on expenses and put your money to better use.
Here are tips for cutting back spending in some of the biggest categories on your budget.
If you're like most people, you probably have a few recurring expenses or subscriptions that aren't giving you much value -- if you even realize you're paying for them. Here are some recurring expenses you may have that you don't necessarily need:
You can try using a free service like Trim which scans your accounts to find recurring charges. Trim even allows you to use them to cancel services on your behalf at no cost.
While insurance is necessary to guard against unexpected expenses in life, it can also eat up a significant share of your budget. From car insurance and life insurance to homeowner's and health insurance, there are ways to save on insurance costs.
According to Energy Star, the average household spends more than $2,000 a year on utilities. Cut back on utility costs with these tips:
The average cost to own a car is $8,600 per year, according to AAA. Here are ways to cut back on transportation expenses:
For most households, food is the largest monthly expense after housing. Whether you're a household of one or many, there are plenty of ways to cut back on groceries and dining out.
There’s no getting around the fact that having kids can be expensive, but there are ways to reduce the cost.
The average dog owner spends almost $1,300 a year on their dog while cat owners spend more than $900 per year. If that sounds like too much, these tips may help you reduce the amount you spend on your four-legged friend.
Ready to start setting aside more money each month? There are many tools that can help you do everything from automatically saving money to investing in the stock market.
If you have trouble setting aside money each month, a microsavings service may be a good place to start to build an emergency fund. Microsavings services work by transferring very small amounts of money from your bank account to a separate savings account. You may hear them called round up the change or round-up apps. The goal is to help you set aside money without even realizing you're doing it.
Some microsavings accounts have minimum deposits or monthly fees. Some just work like deposit accounts while others invest your savings. Here are some of the best microsavings services:
If you're willing to go beyond automated microsavings, another good choice is SmartyPig. This service gives you an online high-interest savings account and helps you set savings goals for specific things. You can set up multiple goals like paying for a trip or your upcoming property tax payment.
Once you build up your emergency fund and you're ready to start investing, these tools can help.
Free (accounts under $5k)
WealthFront is a unique automated investment tool that helps you earn more interest, manage savings, and take the work out of investments. This roboadvisor has low fees and no fees at all for accounts under $5,000. Some of the most unique tools available with WealthFront include the free Portfolio Review tool to evaluate investments and tax-loss harvesting.
Free (some services)
This investment management tool uses financial advisors and algorithms from robo-advisors to help you optimize your investments. If you invest with Personal Capital, you will need to pay a fee, but there are still services available for free including the 401(k) fee analyzer, retirement planner, and investment checkup tool.
Want some help staying on top of your budget? Here are some of the best budgeting tools that take the work out of managing your money.
$4 per month or $40 per year for basic service, $19 per month or $190 per year for Plus
Level Money is a simple tool that works like a meter to show you where you are wasting money and where you are doing well. It analyzes spending habits to show you how to improve your spending behavior.
$6.99 per month or $83.99 per year, free for students
YNAB is a budgeting app that's made for people who want to be really hands-on. Transactions are imported from your bank accounts but you need to manually categorize them into the envelope-based system.
PocketGuard is a simplified budgeting tool that shows you how much you have to spend at any given moment. PocketGuard accounts for bills, typical spending, and savings to show you what's left for the month, week, or day. You can also see what you have left based on spending categories like groceries.
Mint is the top budgeting app for a reason. It's easy to use, free, and allows you to track and control bills, savings, spending, investment, and credit. You can set and adjust a budget and see in real-time how your spending stacks up against what's left for the month.
What is your strategy for budgeting and saving money?
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