By LearnVest.com Staff
Saving, in theory, seems simple: You put some money away and keep your hands off it for a while. But when you have so many other competing real-world demands on your money—from student loans to a desperately needed car repair, exactly how you apply the principles of saving gets more complicated.
We’ve put together a list of some of the most common savings-related questions you’ll need to understand to start saving responsibly.
1. What should I be saving for?
Separate your savings into three main categories: emergency fund, retirement, and goals.
- Your emergency fund will help you handle unexpected situations, like a hospital bill or a pink slip, without going into debt. To figure out how big your financial safety net should be, multiply your monthly take-home pay by six; if you save that amount, you’ll be able to cover your expenses for six months.
- Retirement can seem far away, but you’ll probably need enough money saved up to pay yourself somewhere between 70% to 90% of your current annual income for each year that you’re retired. Calculate how much you’ll need for retirement with the ING Retirement Needs Calculator, but don’t be intimidated by the number. Investing your money should help it grow over time—and the earlier you start saving, the better, because time is one of the most crucial ingredients to building up retirement savings.
Your short-term savings goals are up to you. Saving isn’t about stockpiling cash—it’s about making sure that you’re spending in a way that reflects the things you really value. It’s the difference between an armful of flea market finds you’ll love for two weeks, and finally buying your dream home. Create savings accounts for tangible goals like travel or home renovation, and put money toward them each month.
2. How much of my paycheck should I be saving every month?
Use the 50/20/30 rule for designing your monthly budget. Your living expenses, like housing, food and transportation, shouldn’t exceed half of your income—that’s the 50%.
The next 20% should go toward your money priorities, like paying back debt and building up savings. How you break it down is up to you and your financial situation. Are you desperate to get rid of credit card debt? Or are you debt-free but lacking an emergency fund? Either way, you should allocate at least a fifth of your paycheck to financial obligations.
Then, consider that last 30% discretionary spending—that is, fun stuff, like going out with your friends.
3. But how can I save when I can barely afford rent?
Between your sky-high rent or mortgage payment and your student loan payments, it may feel like you can’t spare a cent for your savings account. A solution could be in your spending habits.
Take a closer look at your monthly expenses. Look for ways to spend leaner, whether it’s by downsizing your apartment or house or cutting down on restaurant dining. Planning your purchases and spending more mindfully will help you free up funds for your savings. If that still doesn’t free up enough money, look for ways to increase your income, by picking up freelance gigs or working toward a raise. Make saving a priority and you can find—or create—a place for it in your monthly budget.
4. I’m still working on a car loan and student loans. How should I balance saving and paying off debt?
You might feel tempted to cash out your savings to get out of debt. After all, it can be frustrating to hold onto a few hundred bucks a month when you could be shoveling it toward your high-interest payments. How you choose to allocate your funds between savings and debt payments is up to you, but it’s important to do both at the same time, even if that means you start small with the savings. That way, if you encounter an unexpected expense, you’ll have money in the bank to protect you from sliding back into debt.
5. What should I do first: build up an emergency fund or start contributing to retirement?
Your emergency fund and your retirement savings are equally important to your financial security. Your emergency fund will protect you if something unexpected comes up in the immediate future, so start building it as soon as you can. Even if retirement seems far away, it’s also important to begin saving now, because the sooner you start, the easier it will be to amass the amount of money you need.
Start saving for these two major goals now, and increase your savings rate as you’re able. Then, once you’ve built up an emergency fund, you can start contributing even more to guaranteeing your stress-free, hobby-filled retirement in the Caribbean.
6. Why can’t I keep my savings in my checking account with my other money?
It might seem easier to just keep all your cash in your checking account, where you can use it as you need to. But besides missing out on potentially higher interest rates, you’ll be making it harder to maintain and protect your savings.
Your checking is where you hold money that you intend to use in the next month or so. Keep savings elsewhere so it is protected from everyday temptations. LearnVest also recommends you go with an online savings account that allows you to create separate sub-accounts for each of your savings goals, including your emergency fund. That will help you keep track of how much money you have for each goal and prevent you from fuzzy mental accounting that allocates one sum of money for two purposes. Sub-accounts will keep you from having to loot your emergency fund to pay for your vacation.
7. What does APY mean? Is it the same as an interest rate?
An APY, or annual percentage yield, tells you how much you’ll earn from your savings account in a year. Your account’s APY takes your interest rate and factors in compounding over time, so it’ll be higher than the interest rate itself.
Here’s how compounding works. If your bank offers an interest rate of 10%, compounded annually, and you have $5,000 in your account, you can expect it to grow to $5,500 in one year. If interest is compounded semiannually, though, you’ll have $5,250 halfway through the year. For the next half of the year, interest will be calculated on that higher balance, which will leave you with $5,512.50 at the end of the year–about $12 more. So your APY, with 10% interest compounded twice a year, is 10.25%. But at today’s ultra-low rates, where 10% is a dream, they look pretty similar.
8. What are all the different types of savings accounts, and how are they different?
When it comes to stashing your savings, a piggy bank won’t cut it. Your bank or credit union offers three options when it comes to savings accounts.
- A traditional savings account is just an account that lets you regularly deposit money. You’ll typically earn more interest than you would in a checking account, but it’s not a whole lot.
- CDs, or certificates of deposit, promise greater returns, but there’s a catch—by putting your money in a CD, you’re pledging to lock it away for a set term. Terms can vary from three months to five years, with interest rates rising the longer you commit. Withdrawing funds before your CD matures can result in a penalty.
Money market accounts offer a compromise: high interest rates and greater flexibility. But they often require a high minimum balance and limit your withdrawals.
9. When is it okay to use my emergency fund?
It’s called an emergency fund for a reason, but an emergency can mean a lot of things. Do you use it when you need a new computer or when your best college friends suddenly decide to take a trip to Mexico next month?
Unfortunately, not the latter. Your financial safety net is for real crises: situations where your health, living situation, or financial security is at risk. For instance, if you lose your job or your car (which you need for work) breaks down, you’ll need to rely on these funds. Don’t even think of dipping into it for some quick cash or an “emergency” massage. But keep in mind that emergencies differ from person to person: A broken computer could be a legitimate financial emergency for a freelancer who doesn’t have a work computer, but a non-emergency for someone who only uses their home computer to watch YouTube videos. No matter what you use it for, remember to replace any money you’ve taken out of your emergency fund as soon as you can.
10. Is it possible to have too much money in my savings account?
If you’re comfortable with your emergency fund, and you’ve already met all your other savings goals, you might be wondering what to do with that extra dough.
By leaving it in your savings account, you’re missing out on opportunities to make your money grow. What’s worse, in a typical savings account, your money could even be losing value because of inflation, which raises average prices over time. Keep just as much as you need for emergencies and goals in your savings accounts, but put the extra dollars to work in investments.