Time and time again, many articles regarding finance cite a source that most Americans wouldn’t be able to cover a $500 emergency expense due to their lack of savings. I think this is especially true for our generation. We’re so focused on trying to pay down our debt and just “make it” into the next month that the thought of having extra cash floating around is almost laughable.
Yes, many of us have other resources to fall back on if things go haywire, such as family members. However, it’s prudent to build a sizable savings. Things can turn on a dime. What would you do if you lost your job tomorrow? What would you do if your family member had to declare bankruptcy and could no longer lend you money from time to time? What would you do if you got into a car accident, totaled the car, and still had to pay because you were determined to be at significant fault? What would you do if someone stole important personal belongings or if you lost your home to a fire or flood? These are all very possible hypothetical situations that can happen to any of us and absolutely overturn our lives.
In this post, I cover all the different types of savings you can (and many that you should) have. I also go into how to start investing and making your money work for you. There is no “get rich quick” part in here. This all takes time and dedication, but the pay off is amazing.
Part I: Budgeting
Part II: Income
Part III: Saving
Part IV: Spending
The Importance of Multiple Savings
It used to be when I thought about savings, I thought about two different accounts: savings and checking. Checking was the money I’d work with on a regular basis for things like groceries, gas, rent, etc. and savings was the money I didn’t touch unless I had to. Pretty simple set-up, but not the most effective if I did have an emergency.
The main reason to have multiple savings set up is to create life barriers and cushions. The more options you have to pull from, the better off you’ll be in getting back on your feet. And, let’s be honest, if you’re in a crisis, the last thing you want to worry about is how the hell you’re going to pay for it. Finance stress is no joke. So, let’s go over the crucial savings you should have:
- Emergency Fund: This is a standard $1,000 you want to have in an easy to access account. If you get into a car accident or find yourself in the ER or need a sudden major house repair, this is the account that you have set aside for those needs.
- 3-6 Months Worth of Expenses: What if you lost your job tomorrow? Unemployment checks typically do not pay what you were at before and they may take awhile to actually come in. In addition, if you had your health insurance covered by work, you probably wouldn’t have that anymore. Thus, any medical expenses you accrue while looking for new work can really put a dent in your finances. This savings account should have everything you and your family need for 3-6 months worth of expenses minimally, which includes rent/mortgage, car payments, groceries, utilities, gas, etc.
- Big Purchases: After you have your emergency funds set away, you can start saving for more big ticket items. For example, this is the account you’d have for saving up for a mortgage, a downpayment on a new car, or your family vacation.
- Bonus – Medical Expenses: Somehow, this one always gets left out of finance guides I read. The US has a terrible healthcare system where, even if you pay hundreds of dollars a month in insurance, you may still be out thousands if you need medical care. This account should include your “max out of pocket” amount you’d have to pay (be sure to do it for the whole family if you’re not the only one on the insurance) and enough for 5-10 regular doctor office copays. If you have things like glasses and contacts, be sure to include enough to get those updated annually (typically includes cost of 12 months worth of contacts, new frames, and/or new glass to put in the frames).
Savings Accounts: Different Types for Different Reasons
Standard Savings Account
Everything I discussed above would be in a standard savings account. This is a savings account you can set up through any bank. I’m not loyal to any bank in particular. I recommend that you go with whatever bank you’re most comfortable with. For most people, this is where they have their checking account. My only tip in this area is to keep the savings accounts holding large amounts of savings (i.e. your 3-6 month expenses, big purchases, medical, etc.) at a separate bank to reduce the temptation to do an easy transfer of funds if you have a little too much fun with frivolous spending.
IRA: Traditional vs. Roth
IRA stands for “Individual Retirement Account”. We’ve all heard of 401k. I used to hear the adults in my life go on and on about when I was growing up. I didn’t even know there were other types of retirement accounts until after college. The idea of needing to diversify your retirement accounts fall much in line with the previous post on income: this is going to be your income one day, don’t rely on one source.
To make it simple, the difference between the two different IRA is how they’re taxed. A Traditional IRA is taxed later when you retire and start taking distributions from the account. A Roth IRA is taxed now, but you don’t have to pay taxes on it when you retire. Here’s a comprehensive guide on it, including which one might be best for you to invest in.
Also note, there are limits to an IRA. First, you can’t contribute more than $5k in one year, as it stands. This is in total. So, if you have a Traditional and Roth IRA, the contributions to the two combined can’t be more than $5k. There’s also a cap on salary. If you make too much annually, you’re not allowed to contribute to an IRA. All that is explained in the guide in the previous paragraph in more detail.
401k Savings
For those of us in a traditional employment setting and working full-time, a 401k is probably available to you. You have to set it up through your employer because it’s not automatic. Most employers will match your contributions up to a certain percentage (i.e. they’ll match you up to 3% of your salary). Just like the IRA, your 401k has caps, too. Currently, you’re capped at putting in $18,000 to your 401k annually. Again, you can read more about it here.
Ultimately, this account is a great opportunity to save towards retirement because you’re not the only contributor. If you happen to switch employers, you can take your 401k with you by rolling it over, but just watch out for those fees and be sure to look at all your choices carefully if you find yourself in that situation.
Investing Like a Pro on a Dime
My Favorite App for Easy Investing
I’m sure you’ve heard of it by now. Stash has grown significantly from when I started using it a year ago. When if first came out, I did invest only $5 because I thought that, if it was a fluke, I could spare $5. All the other investing options I had looked at by that point required a couple thousand dollars, minimally. Being completely new to the investment game, I wasn’t comfortable putting forth that much upfront. Over time, I’ve obviously invested more and I have gotten returns from Stash.
You literally only need $5 to get started with investing with Stash. You’re investing in ETFs (more below), which are less riskier than buying stocks individually. However, one of the more recent programs does feature buying into individual stock options, if that’s where your interests lay. The catch is that the options for companies and stocks aren’t as lucrative as other trading companies.
If you use this link, Stash will give you your first $5 for free when you sign up. AKA, you can try it out without paying a penny yourself.
Types of Investment Options
You never want to go into an investment by putting all your eggs into one basket. High risk does get you high returns, but stupid risks are just that: stupid. To reduce your risk, you want to diversify your portfolio. This essentially means investing in many different areas. If you’re low on funds and looking for a safe starting point, start with an ETF, mutual fund, or index fund as they provide a diversified portfolio. All the options below are ideal for holding in the long-term with the exception of stocks. Day trading can be successful, but be sure that you are confident in reading the market before embarking on that endeavor.
- Bonds: Bonds are a great investment for anything long-term. As with all investments, there are many different options for what type of bonds you can buy.
- Stocks: Typically, when you buy stocks, you want to buy a couple hundred per company to see any significant change. If you don’t have the financial capita to go that route, you can take a peak at that Stash app, or you can look into mutual funds (more below).
- ETF: ETF stands for “Exchange Traded Fund”. These funds tend to include a variety of different investments including bonds, stocks, and securities. The main difference between an ETF and a regular mutual fund is that you can trade ETFs on the stock market. When you invest in funds on Stash, this is the type you’re investing in.
- Mutual Fund: This is a fund that is a diverse portfolio of funds. As a standard, it includes stocks, bonds, and other assets and securities. They’re managed by professionals; you just buy in. This is a great starting point to invest in if you’re new to investing.
- Index Fund: This portfolio has a similar layout to mutual funds and ETFs, but the main goal is to match the market index. Overall, these funds get you broad exposure with low operating expenses. Index funds are passive and are great for retirement accounts and holding them in the long-term.
- Other options to explore: shareholding, angel investing, real estate
Rule of Risk
If you’re wondering how much risk you can take, then there’s a simple rule to determine it. It’s just your current age subtracted from 100. The final number is the percent of your portfolio that can be high risk. The reason the equation is based on age is because as you get older, it becomes much riskier to take on high risk ventures than if you’re young. A 25 year old trying to recover from a high risk fall out is a much different situation than a 60 year old who recently retired. An example how the equation works is below and I performed the equation using my own current age:
100 – 25 = 75 = 75% of my portfolio can be high risk
You do want to take on some high risk options as the greater the risk, the greater the reward. However, you don’t want to be nonchalant about it. Do thorough research. Gain a complete understanding of the investment. Get to know the long-term. Do these things before you put any money behind anything, especially high risk ventures.
Handy Tips for Saving $$$ in Your Day-to-Day
- Join rewards programs. Most reward programs are free. Avoid joining reward programs that require you to obtain a credit card through that company and instead opt for reward programs that hook up to your current debit account. A great example is Target’s REDcard. They do have a debit option. I literally saved hundreds of dollars by having this reward account as I get a 5% discount per purchase plus some exclusive coupons.
- Always have something like Ebates hooked into your browser. Most of my shopping can be done online. Ebates runs on your browser (when you give it permission). Before check out, Ebates will go through and coupon comb. Then, it will apply any relevant coupons to your order before you submit it. It will also give you a percent (usually between 2% – 6%) on that purchase. Ebates pays out in quarters. So, all your cash back from purchases over a series of 3 months get paid out at the end of it. It adds up pretty quickly and it’s just another way to save big bucks.
- Wait for the sale. Many big companies have at least one annual sale. In addition, most companies have sales pretty regularly. It’s always a safe bet to wait for a holiday weekend as there’s almost always a guaranteed sale. Just be sure to know what you want to get when it’s time so you can snag it before it’s gone! Waiting for the 15% off, 20% off, 25% off, etc. sale has saved us hundreds of dollars, especially for big purchases.
- Coupon scope before buying. Most places like Target, Safeway, Albertson’s, etc. will accept company coupons at checkout. For example, if you’re buying diapers, you can utilize the coupon that Target has and you can utilize a coupon that Pamper’s has simultaneously. Always check the main company’s website (i.e. General Mills, Pampers, etc.).
- Grocery tip: It’s much cheaper to cook something yourself with ingredients than to buy the frozen package. Not only is it cheaper, but you can also make it with better quality and typically more of it, too, so that you have leftovers.
Next Week: Part IV
WHAT TO EXPECT AND LOOK FORWARD TO
Next week, we’ll be ending the series! The final part is focused on spending. In this upcoming section, we’ll be discussing minimalism and not buying into consumerism, how to determine what’s worth your dollar, managing mindless spending, and how it all factors in with budgeting, income, and saving! I’ll also be walking you through my method for buying once and not buying again.