Chapter 5: Save Money
Setting aside cash on a regular basis is a habit worth getting into. It allows you to achieve your financial goals and provides a safety net during financially-challenging times.
How much should you save?
A general rule of thumb is that you should set aside 10% of your monthly net income. However, depending on your financial goals, you may want to save more. If you can afford to set aside 10%, you typically do not want to save less, but if money is tight, begin with whatever you can afford, even if it’s only a few dollars.
Establish an emergency fund
In addition to saving for specific goals and periodic expenses, it is important to establish a general emergency fund. Unexpected things happen, and without a savings cushion, you may find yourself turning to credit or skipping bills if, for example, your car breaks down or you lose your job. Financial experts recommend saving at least three to six months worth of essential living expenses. If emergency fund has less than that, determine how much you can set aside each month until you reach your goal. Even if you are paying down debt, you should still set aside something each month if you have little or no savings now.
Where should you put your savings?
Because you may be tempted to spend it prematurely, putting your savings in your checking account is usually a bad idea. There are many options for storing your savings:
- Savings account – With a savings account, you deposit money with a financial institution and receive interest or dividends in return. You can withdraw your money at any time (making it a good choice for emergency savings). Savings accounts are insured, meaning you will still be able to access your money if the financial institution goes out of business.
- Certificate of deposit (CD) – CDs are also offered by financial institutions, but you are required to leave your money deposited for the term of the CD. If you withdraw early, in most cases, you will have to pay an early withdrawal penalty. CDs are insured and generally have a higher interest rate than savings accounts.
- Money market deposit account – Money market deposit accounts are similar to savings accounts, but the interest rate is variable and usually higher as well. They are insured and may come with limited check-writing privileges.
- Money market mutual funds – Money market mutual funds are mutual funds that invest in short-term debt obligations, such as Treasury bills and CDs. While generally safe, money market mutual funds are not insured and provide no guarantee against loss.
- U.S. Treasury bills – Treasury bills are short-term debt obligations of the U.S. government.
With the above options, there is little to no risk that you will lose the money you deposit. Low risk is important for emergency and short-term savings. However, while you will earn more interest than with a checking account, the interest rate is still fairly low. For long-term goals, it makes sense to put at least a portion of your savings in investment vehicles with a higher return, such as stocks and bonds. There is a risk that you will lose some or even all of the money you invest, but the risk is less over a long timeframe. You can further reduce your risk by choosing investments carefully and diversifying your investment choices.
Make saving easy
There are many techniques that can be used to jump-start saving:
- If you have direct deposit, have a portion of your paycheck directly deposited into your savings account. Or set up a regular automatic transfer from your checking account to your savings account. What you don’t see, you don’t miss.
- When you receive a raise, put the extra cash in savings instead of spending it.
- Deposit bonuses, income tax refunds, and cash gifts from birthdays, holidays, or other special occasions into savings.
- Save all of your loose change. A quarter here and a dime there will add up.
- Once you’ve paid off your car or other debt, start putting the same amount in savings
- Save even if you have debt. If your debt carries a high rate of interest, it is to your financial benefit to concentrate on repayment, but you should find a sensible balance. By saving even a little as you are repaying debt, you’ll start an emergency account, kick the habit of borrowing, and establish a savings routine.