Having a sizable savings sometimes seems like an impossible dream. If you’re buried in student debt, working in the gig economy or struggling to find reliable work at a living wage you may be more worried about survival than saving.
It’s not easy, but saving is a critical part of building for a better financial future. Saving is a worthwhile goal even if it means cutting luxuries from your budget. There are no hard and fast rules on how much you should save by any given age. Understanding the different types of saving and setting goals that are appropriate to your income can help to put you on the saving track.
The Three Types of Savings
Savings are savings, right? You take any money you don’t spend, put it in the bank and you’re saving! Well, not quite. There are three distinct types of savings and each requires its own strategy:
- Your Emergency Fund
- Your Goal-Oriented Savings
- Your Retirement Savings
All of these are important, so let’s look closely at each of them.
Your Emergency Fund
Your emergency fund is a buffer, a shield against unexpected events that can put a dent in your finances or force you to fall back on credit cards, payday loans or other high-interest debt.
Your emergency fund comes into play in situations like these:
- Medical Expenses.
- Replacement or Repair of Major Appliances
- Car Repair Expenses
Most experts say that your emergency fund should be large enough to cover three to six months of living expenses. Three months is the minimum, six months is ideal. If you have to draw on your emergency fund, treat it as a loan from yourself and pay the money back into the fund as soon as possible.
You might need fast access to your emergency fund, so you should keep it in a liquid account where you can withdraw at any time. Emergency funds should not be placed in potentially volatile or risky investments. A high-yield savings account with FDIC insurance is ideal.
Goal-oriented savings are funds that you set aside for specific goals. This could be anything from a vacation to a wedding to a car to a down payment on a house. You can and often will save for more than one goal at the same time.
If you’re saving for a specific goal, you’ll need a target. Do some research and come up with an estimate of the resources you will need to meet your goal. You’ll also need an idea of when you want the money to be available.
If you’re saving for more than one goal at the same time, you’ll need to set priorities. Based on the amounts you need to set aside and the time frame for each goal, decide how much you want to set aside each month for each goal.
You’ll want to keep these funds in secure, insured accounts, but you won’t need immediate access to them. You may not want immediate access, which could tempt you to tap your savings for other expenses. Consider Certificates of Deposit (CDs) for holding goal-oriented savings.
Retirement may seem far away, but it’s never too early to start saving for it. Getting a head start when you’re young can put you in much better shape down the line.
The US government wants you to save for retirement and has provided a number of tax incentives to promote retirement savings. Consider taking advantage of these tax-advantaged options:
- A 401(k) plan. If your employer offers 401(k) accounts, consider opening one. If your employer offers both traditional and Roth 401(k) plans, consider offering both types: they offer different but compatible tax advantages and withdrawal options. If your employer will match your contributions up to a certain percentage of your salary, contribute enough to take full advantage of the match. It’s free money!
- An IRA. If your employer does not offer a 401(k) plan, consider opening an individual retirement account or IRA. IRAs are also available in traditional and Roth variants and again it is often sensible to have both.
- A 401(k) and an IRA. You can have both a 401(k) and an IRA and in some circumstances, it makes sense to have both. If you’re considering setting up retirement accounts you should do some research on the different options and consider consulting a financial adviser to make sure you get an account or combination of accounts that are appropriate for your goals and needs.
Retirement saving is a long-term goal and it makes sense to place retirement funds in diversified stock and bond investments. Many 401(k) plans and IRA providers offer a variety of investment options.
Your retirement savings goals will vary with your income and your retirement plans. If you hope to retire at 60 you’ll have to save more aggressively than you would if you plan to work through your 60s. As a general rule, you should try to have one year’s salary saved by 30, three years salary saved by 40 and 5 years salary saved by age 50.
Saving simultaneously for an emergency fund, goal-oriented savings and retirement can seem like a daunting task. If you can’t meet the ideal targets don’t give up. What’s important is that you are saving and you keep putting some money into each category every month. Budgeting your income carefully and cutting down on unnecessary spending can help you build your savings. Remember to set realistic goals, do your best to meet them and start saving early.