Hey everybody! Hopefully by now you understand how important savings is to achieving financial independence. If you still need convincing, I’d recommend checking out the following posts:
Motley Fool - An Open Letter to Everyone Under Age 30
Mr. Money Moustache - The Shockingly Simple Math Behind Early Retirement
Get Rich Slowly – How Do I Start My Savings After Graduating College
However, a question I regularly see is “What am I supposed to do with the money I’ve saved?” This is a valid point, as you don’t want to keep it under your mattress (fire, robbers, and poor back support are all reasons to avoid this Great-Depression-era technique). So, here is my advice to newbie savers:
- Take advantage of your employer’s 401k plan. This is the simplest way to invest since you fill out a form once and then it’s automatically taken out of each paycheck. Even if your employer doesn’t offer a match, this type of plan has tax benefits that are important to a diversified portfolio. If it does have a match, contribute at least as much necessary to take full advantage of the match. Otherwise you are just leaving money on the table. You can contribute up to the federal maximum level (2013 = $17,500); however, keep in mind that there are penalties for withdrawing early.
- Get a savings account. I use Capital One (formerly ING) for my emergency savings. This is the amount I think I may need in the event of a major life disrupting event (loss of employment, needing a new car, significant health issue, etc). Personally, it helps me to keep this money separate from my day-to-day funds. If you’re curious how to determine this amount, I recommend checking out a post by Jordann at Making Sense of Cents.
- Set up a Roth IRA. Once you feel that you have enough emergency savings, I recommend getting a Roth IRA. I suggest you check out Vanguard, as they have the some of the lowest fees in the industry. If possible, contribute the maximum allowed by federal law (2013 = $5,500). Since these funds are after-tax, the government will even let you withdraw your contributions (but not the gains) in the event of a hardship. Depending on your situation, it may even make sense to use this as an emergency fund, since you can only contribute so much each year. The perk of this account is that you don’t have to pay tax on the gains! Woo-hoo for free money! Also, keep in mind that you can contribute through April 15 of the following year.
- Start personal investing. Hopefully you will eventually come to the point where you need another outlet for all this money you are saving! I have Lending Club and Scottrade accounts to fulfill these needs. It requires as much research as you want it to. Review stocks, follow blogs, watch the news….or just invest in an index fund (or specific loan type for Lending Club) and the work is done for you.
Personally, I’d recommend paying off debt before starting an aggressive savings plan (I recently paid off my student loans, and it felt AMAZING!). However, it is important to do an analysis of each specific situation (considering interest rates, rates of return, benefits of the loan, such as deferment for some student loans) before making a decision what is a priority.
Also, note that I’m not adding Traditional IRA because I need to save for the years prior to 60, rather than have a ton more money tied up in funds that have penalties associated with early withdraw. This option may be better for some people, specifically those who expect to be in a lower tax bracket during retirement.
What do you do with the money you save each month? Are you saving for anything in particular?
Flickr Image Source: “Dollars” by 401(K) 2013