Things To Consider When Starting To Save…For Anything
Everyone hears they need to “save.” Save for the future, retirement, emergencies, college, and on and on and on. These people in your life telling you to save are not wrong, savings are extremely important.
But, one thing potentially missing from the conversation is the best way to save for a given goal.
The bullet points listed below are important aspects to consider when thinking about savings. I’ll dig into more detail with specific sections for each bullet point.
Here are my savings considerations, presented in no particular order:
- Time frame
- Taxes (Taxable vs. Tax-Deferred)
- Cash vs. Investment
- Balance Minimums
NOTE: before jumping in, all the bullet points listed above should be taken in context of the entire savings goal. By that I mean each bullet will most likely have an advantage or disadvantage based on the purpose of the savings. Also, each bullet point is most likely going to affect other bullet points in some way.
The time frame of your savings is extremely important and will determine quite a bit about the specific type of savings vehicle you choose.
For example, if you are saving to cover emergency expenses there are more important attributes to consider than if you are saving for retirement. Emergency savings need to be after tax dollars, easily accessible and having them insured (FDIC) won’t hurt as well.
Retirement savings on the other hand will most likely be taxed deferred (ie pretax dollars), invested (stocks/bonds/etc.) and the accessibility of these savings will be less than your emergency savings.
The point is there are advantages and disadvantages based on the time frame of when the savings will be needed.
All money gets taxed. Make no mistake. Uncle Sam will get his, of that, you can be sure.
But…WHEN your money gets taxed can make a huge difference. When it comes to taxes and savings there are two terms to be familiar with.
- Taxable: savings that have ALREADY been taxed.
- Tax Deferred: savings that have NOT been taxed yet.
Certain savings strategies work better with certain tax statuses of money. For example, using a 401(k) as an emergency savings vehicle is a horrible idea because if and when the money is accessed, it will be taxed at the owner’s current tax rate but will also be assessed a 10% penalty tax for dipping into those monies too early.
Cash vs. Investment
Time frame, risk tolerance, savings goals, asset allocation…all of these and more come into play when determining whether to save with cash or save with investments.
Cash savings are generally used for things where risk tolerance (ability to tolerate losing money) is low or nonexistent. Emergency savings are another great example of cash savings but also saving for a mortgage, a trip or a new car. All of these savings goals generally assume we want the money to be there over a given time frame.
Or said differently, it would be horrible to save $100,000 for a house and then have 40% disappear because those savings were in technology stocks.
Fees will cut into overall savings, whether investing in stocks for retirement or putting aside a fixed amount per month for a future home down payment; fees will result in less for the goal.
How mad would you be if you couldn’t get a hold of your money when you need it? Or, if there was a penalty for accessing it?
Personally, for me, I’d be furious if a bank or some other financial institution told me I couldn’t have my money!
But this is the reality. Based on the type of savings account and vehicle chosen there will be rules that need to be followed to avoid these penalties.
For example, with a 401(k), there is a 10% withdrawal penalty if the money is withdrawn before age 59½.
Another one, banks limit the amount of transfers out of savings account to 6 times per month. Penalties vary by bank, but they can include closure of the account and fee penalties.
Sometimes there are balance minimums that need be to be met so maintenance/penalty fees are not assessed.
Checking, saving and investment account can all, potentially, have balance minimums.
These days it seems most of these requirement have gone by the wayside, or at the very least are marginal amounts. The important thing is to just be aware and ask the question of whoever is providing the account.
Some things are insured and some things are not.
Checking, saving, money market, cashier’s check, etc. are all insured by your bank up to $250,000 per individual. For example, say you have $250,000 at Bank #1 and $250,000 at Bank #2, all of your money would be insured under this scenario.
Other things are not insured. For example if your IRA account has a bunch of technology stock investments, this would not be covered by FDIC insurance. Technology stocks are investments and thus the investor bears the risk of potentially losing money.
To Wrap It All Up…
Long story, short…think your savings goals through and choose the most appropriate vehicle to get the job done. There are many things to consider, the above list is by far not exhaustive of all considerations but it is a good start. Thinking through all the topics outlined above will definitely help lend some clarity to your savings goals.