Let’s say you are, financially, on the right track. You’re able to pay all your living expenses and bills with your own income, you never got yourself into trouble with credit cards and therefore have no consumer debt, you made it through some sort of higher education without borrowing money to cover your tuition, and you’ve been determinedly squirreling away money for a year or so (possibly even longer). You’re not only financially responsible and debt-free, but you also live well within your means. This has allowed you to dedicate some of your income to a retirement account through your employer and set another portion of your paycheck aside in a separate savings account.
Congratulations! Release those balloons and all that confetti that’s up by the ceiling, because you have just won the game of Who Wants to Have a Savings in Their Twenties and it’s time to celebrate. The hard work is done! ..right?
Not so fast.
It’s wonderful if you have a sizable chunk of money that you’ve earmarked as savings. You are ahead of the curve and in a financially good position. But you’re not done yet. The next step is to understand what all you can do with this money that’s just hanging out in your savings account down at the bank, and then make a decision that is going to put that cash to work for you in the most efficient way possible. Let’s look at exactly how to do this.
Determine How Much in Savings You Have
Sounds simple, right? For the most part, yes, understanding exactly how much you have saved should be easy for someone who’s obviously financially savvy enough to grasp the importance of saving in the first place. For most of us, that’s going to involve a quick glance at a bank statement. But just because it’s a simple task doesn’t mean you should skip over it; just like you know your monthly budget, you’re going to want to know what you’re working with so you have a clear idea of all the options that are available to you. Guesstimating won’t cut it – know what you have.
Give Yourself the Ability to Float in Sink-or-Swim Situations
The very first thing you need to establish is an emergency savings fund. An emergency fund will allow you to survive in unexpected situations and worst-case-scenarios. If something major and unforeseen happens to you tomorrow – you lose your job, your house floods, your car is totaled, you’re injured and cannot work – your future is going to be greatly influenced by whether or not you’ve established an emergency fund for yourself. You’ll either be able to use the money you’ve set aside for a crisis to minimize the damage, solve the problem, and move on with the rest of your finances secure, or you’ll flounder as you try to gather up money from any account in which you can find it, incur a load of debt trying to make up the difference, and become trapped in a situation you weren’t financially prepared to handle.
Ideally, an emergency fund is going to cover 3 to 6 months of expenses. To determine the exact amount of your individual fund, therefore, you need to total up every bill and expense you always and necessarily incur from month to month. Think things like living expenses (mortgage/rent and utilities), food, insurance, and transportation costs. In a real emergency – like if you lost your job without warning tomorrow – you’d probably be able to cut these “necessary” expenses even further, but it’s always best to estimate high so your normal monthly numbers will work perfectly for estimating what you’ll need in your emergency fund. Once you’ve determined your absolutely necessary monthly expenses, multiply this number by 6: this is your ideal emergency fund total. Depending on your situation, you may feel confident with just 3 months’ worth of cash earmarked for emergencies. This is fine – after all, the range is 3 to 6 months – but if you’re starting on the low end I would suggest continuing to budget a small amount of money every month to keep contributing to your emergency fund. For example, set aside $20 to be added to your fund. The small amount ensures continuing contributions aren’t too taxing on your budget and you’ll still be able to steadily grow your fund.
Take Advantage of the Benefits of a Roth IRA
Once your fund is established, you need to determine where to put it. Because an emergency fund should be used for true emergencies, not just oops-I-overspent-this-month situations, you should be able to have the money in an account that is a teensy bit less liquid than a regular savings account down at the bank. The perfect place for an emergency fund is a Roth IRA, because while it is an account designed for retirement and future savings, you can withdraw the principle at any time without penalty. Let’s assume you’re starting with an emergency fund of $5,000 and you place it in a Roth IRA. This is the principle. Future contributions that you make into this account are also considered part of the principle. You can withdraw this amount, without penalty, at any time.
The important thing to remember here is that while you can withdraw any amount of the principle, you cannot withdraw the earnings that you make off that principle; if you do, you’ll pay a tax penalty. So the point of having an emergency fund in a Roth IRA is that because true emergencies are, thankfully, quite rare, the money that you earmarked for emergency savings can work to earn more money for as long as it is in your Roth account. You can continue to make more contributions and earn more money, but your contribution would also be available to you to withdraw and use if you ever needed it. And if you did have to use your principle, the money you had earned off your contributions to the account would still be there acting as a retirement savings. If you’re interested in playing around with the numbers, Bankrate has a great Roth IRA calculator that accounts for a variety of factors and can give you an estimated worth of an account over time.
Make Your Money Work Hard
Just like your emergency fund money is working for you by utilizing compound interest and giving you a return on your investment, the rest of your initial chunk of savings should be employed to do the same thing. Since we already worked with the premise that you had $5,000 for an emergency fund, let’s continue the example and say you had an additional $5,000 in savings to figure out what to do with. You could take $2,500 of that amount and invest it into the market using a financial institution like Vanguard. Vanguard is a great institution because it’s extremely friendly to use for personal investors. A major reason for this is because it is extremely low-cost relative to other organizations that do the same thing. What makes them unique is that the company is actually owned by the mutual funds it runs, making it extremely accountable to its customers; there are no outside, third-party shareholders involved.
A great way to begin investing money in the market is through index funds. Mr. Money Mustache, a really interesting personal finance blog, has an entire, detailed post on why and how to invest in the stock market with index funds. It’s well written and clearly explained, so if you don’t know much about index funds I would suggest heading over and giving it a read.
You may choose not to go with an index fund – and that’s fine. This is your money we’re talking about, after all. But the bottom line is it’s a good idea to invest a bit of what you’ve saved somehow, some way. People don’t accumulate wealth by stuffing their dollars into the mattress; they invest. I understand that many millennials, after bearing witness to the housing market bubble as it is imploded, crashed, and took the economy with it, are wary of investing in the stock market. In all honesty, I don’t feel a whole lot of trust with the market myself. That’s why I try to diversify my savings and why I advise others to do the same. While I wouldn’t say you should throw all your money into the stock market, I do know that as twentysomethings we have the most important factor of successful investing on our side. That, of course, is time. We have time to ride out the highs and inevitable lows, and we need to take advantage of that by dedicating some portion of our money to investments. By keeping our savings diversified, we’re better prepared for the risks that come with investing so we may reap the rewards of putting our money to work for us.
Keep Some Liquidity for Short-Term Goals
The entirety of your savings doesn’t have to be socked away into investment accounts or high-interest savings accounts that make your funds harder to access. We all have things we want and dreams we want to see realized – you goals could be to travel, to start your own business, or to purchase one or two big-ticket items (like replacing the twenty year old couch with some new living room furniture). Since these are things that you plan to spend money on in the next few years, it’s smart to keep a portion of your savings in a very liquid account that you can easily access.
Continuing our example, we have $2,500 left in savings to allocate. What we can do is research banks and credit unions to determine our best options. You want to look for a high-yield savings account, or an account that carries a 1% interest rate or more. I would start with credit unions, because those typically will offer better rates than big banks. If you can’t find any local options, many people speak highly of the online bank Ally; again, do a bit of research for yourself so you can determine what works best for your situation. Once you’ve found an institution and an account, you can put in about $1,500 and now use this account to hold your short-term savings.
Treat Yo’ Self
I’ve said it before and I’ll say it again: living frugally and being fiscally responsible does not mean you live in a state of deprivation. If you have no debt, have saved your pennies and invested your money wisely, I believe you deserve a bit of a treat. It might be a vacation, something new for your home, or something new for yourself; whatever it is, it is definitely something you would not normally think of spending your hard-earned money on. But it’s hard to be so strict with yourself every single day, week, month, and year, and in my experience, watching your budget can be a lot like watching your diet. If you are hard on yourself and you never, ever, allow yourself to indulge, the likelihood of you binging – whether it be on your favorite treat or on a mindless impulse buy that you later regret – is greatly increased.
Of course, just because your treating yourself does not mean you get to go on a thoughtless shopping spree and blow through what is left of your savings. Let’s remember the example we’ve been working with. We had $5,000 in our emergency fund that we placed in a Roth IRA, leaving us with $5,000 in savings. We continued to make that money work hard by investing $2,500 into mutual and index funds, maybe through a reputable financial institution like Vanguard. We kept $1,500 in a very liquid savings account – although we did our research and chose a high-yield account so we could still make a bit of money via interest. That leaves us with $1,000.
Again, having $1,000 to use on some fun stuff doesn’t mean go crazy and abandon all frugality. Be smart about your spending – for example, if you want to take a vacation, look for deals on flights and accommodations, travel in the off-season when everything costs less, and do what you can to minimize your expenses. If you’re wanting to take care of some home improvement projects that you’ve been putting off, purchase the necessary supplies but then do the work yourself instead of contracting out the job. If you have a big-ticket item on your wishlist, question the purchase thoroughly just like you do as if it were an everyday spending decision. Will it improve some aspect of your life? Is it useful? Do you want it because you will get something positive out of it, or is it something that’s more of a status symbol than anything else? In other words, you want the things to purchase to be investments in themselves. A dSLR camera or a new computer and software programs are great examples of investment items, as is any kind of equipment for a new hobby or activity. Say you could use a nice tennis racket if you want to play more in local tournaments, or a new 3 season tent so you can get out and go camping more often – you get the idea.
Keep Contributing to Your Accounts
Now that you’ve allocated your original $10,000 in saved-up cash to various retirement, investment, and savings accounts so that you are making your money work as hard as possible for you, you may think you are finally done. No, not really – now your task is to keep your good habits going. You’re awesome for having initially saved up such a large amount, but that doesn’t mean you get to quit saving now.
Ensure you “pay yourself” every month, just like you pay your bills, by contributing money from your income to your new accounts. This applies even if, after continuing to pay into your retirement through work and taking care of all your expenses, you only have $100 left over every month for savings. Don’t feel like you shouldn’t contribute just because it’s a smaller amount - every little bit counts. You can put $20 toward your emergency fund, $30 toward your investment account, and $50 to your savings. This is just a quick example; only you can properly analyze your priorities and allocate what you have available in a way that works best for you. The important thing is that, regardless if you have the ability to save 5 or 50 percent of your income, you keep saving. This is one job that is never done – but if you never quit, you’re rewarded with financial stability, security, and one day, complete financial independence.
You’re off to a great start. Now that you know what to do with the money you saved, I hope you feel even more motivated and empowered to keep up the savings!