You've covered the necessities like rent, the light bill, and groceries, and now you've
got some money left over.
You know you're supposed to be saving, but where do you even start?
Understanding a few principles can help you prioritize your savings goals and figure out
where to put your money.
The first principle is to focus on retirement.
For most people, retirement is likely to be the biggest financial goal of their lives,
so you may want saving and investing to be a major focus.
But if there are financial burdens that could jeopardize your retirement savings, removing
them is an important priority.
That's why an emergency fund is the place to start.
Unfortunately, most Americans don't have enough saved to take care of a surprise $500
expense like an emergency room visit or car repair, let alone something more severe like
losing your job.
To protect your long-term savings, you can make setting aside three to six months'
of expenses a top priority.
To figure out how much you need, add up your essential monthly expenses, things like rent,
utilities, and groceries.
**beat of pause**
It may be helpful to keep your emergency fund in a separate savings account that you can
access quickly but won't be tempted to borrow from for day-to-day expenses.
This account can act as a buffer, so you won't have to pull out the credit card or raid your
retirement account when you find yourself in a jam.
Once you've got an emergency fund, consider shifting your focus to another common retirement
savings obstacle: high-interest debt.
High-interest debt is anything over 5%, so credit cards, personal loans, and especially
payday loans.
Debt with a high interest rate is likely to grow faster than any money you invest for
retirement.
Debt that doesn't reach that 5% threshold,
things like most federal student loans or mortgages, can be approached a little differently.
It's important to make regular payments on these, but don't worry about trying to
pay them off early.
You'll likely earn more over the long run by investing than paying off low-interest
debt: as of 2019, the average annual return of the S&P 500 over the past century is about
10%, much higher than the 4.5% interest rate on a subsidized federal student loan.
Now, it may make sense to put money toward retirement before paying down high-interest
debt if your employer matches contributions to a retirement plan, like a 401(k).
If your employer offers a match, contribute just enough to get the full amount.
You don't want to pass up free money, so it can be a good idea to prioritize getting
that match over paying down debt.
Once you've got debt under control, you're ready to focus even more on retirement.
A commonly held rule is to save at least 15% of your income for retirement.
So where should you put all that money?
Consider using tax-advantaged investment accounts and minimizing fees to potentially maximize
your savings growth.
Retirement accounts like 401(k)s and IRAs offer tax benefits that can potentially allow
your money to compound more quickly.
However, 401(k)s sometimes carry fees that can eat into savings.
If your employer matches, you should still contribute enough to get the full match.
But you may want to consider contributing anything beyond that to an IRA, which might
have lower fees and more investment choices.
After maxing out retirement savings, the next step pretty much depends on your circumstances.
But the same principle applies: using tax-advantaged accounts can help to potentially maximize
your savings.
For example, if you're saving for a kid's college, consider contributing to a 529 plan.
It might seem strange that a child's education is a lower priority than something as far
off as retirement,
but remember, borrowing for college might be easier than borrowing to fund your golden
years.
Health care is another major expense that may require saving.
If you're on a high-deductible health plan, a health savings account is another tax-advantaged
account you might want to consider.
HSAs are designed to let you set aside and invest untaxed cash to pay out-of-pocket for
medical expenses.
The combination of tax benefits and potential growth from investments may make an HSA an
attractive vehicle for saving for medical expenses in retirement.
If you're lucky enough to have maxed out all the tax-advantaged accounts that are available
to you, you could also consider investing for long-term goals in a regular, taxable
brokerage account.
A final principle to remember is that investing may not be prudent for short-term goals, like
a vacation or a down payment on a house.
You may not have time to recover from market downswings, so you might also want to consider
using a high-interest bearing savings account rather than investing money you'll need
in the next few years.
If you've made it to this point, congratulations you're a savings pro.
The important principles to remember are to focus on retirement, use tax-advantaged investment
accounts, and invest for long-term rather than short-term goals.
Whatever comes next, make sure you're keeping the basics well-funded.
Thanks for watching.
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