How to Save What You Earn
Depending on where you are in your life and career, retirement may be on your mind, or it may be in the distant future. Either way, starting to save as early as possible can have a huge impact on your financial future.
Saving in your 20’s
The earlier you start saving, the more you’ll have when you need it. Sounds like common sense, right? In a way it is, but the numbers are more powerful than you are probably aware.
Let’s say that Jane and Joe are both graduates of your school and are thinking about saving for retirement. They both started at about the same salary at age 22, and will get the same salary increase of 2% per year until they retire at age 65. They both invest 5% of their income each year and earn 8% interest annually. By starting to save just 5% of her income at age 22, Jane has accumulated almost 40% more retirement savings—over $200,000!
| Jane | Joe |
|---|---|
| 22 years old | 30 years old |
| Income $25,000 | Income $30,000 |
| Invests 5% | Invests 5% |
| Will retire at 65 years old | Will retire at 65 years old |
| $531,748.81 at retirement | $326,029.31 at retirement |
Make Your Money Work for You
Using a standard bank savings account is a good start, and the convenience of having the funds available anytime may outweigh the downside of earning a lower interest rate. If you have already established an emergency fund, these options will make your money grow faster over time.
Options to make your money grow faster
Certificates of deposit (CDs)
CDs are safe vehicles for short- or long-term investing. Typically you purchase a CD for specific period of time, such as one to 2 years. At the end of this period, the CD matures, and your initial investment plus interest is returned to you. You will be penalized (usually 3 to 6 months worth of interest) for withdrawing the funds early. CD interest rates vary with market interest rates. You can purchase a CD from your bank or a brokerage firm. CD rates vary, so shop around to get the best deal, however, make sure you only invest with a reputable seller.
Mutual Funds
Mutual funds purchase investments and sell shares of the bundle. Mutual funds offer more diversification than purchasing individual stocks, but they can still carry a high amount of risk depending on the underlying investments. For example, a money market fund is a less-risky short-term investment that will often pay a higher annual interest than an ordinary savings account. Other mutual funds invest in stock from certain industries, countries, or types of companies that may offer the chance at higher returns for significantly more risk. You can purchase shares of mutual funds with your 401(k) or 403(b) or independently from a brokerage firm or directly from a mutual fund company.
Saving for the future is a complex topic. You should do additional research and consult with a professional financial advisor to find a savings and investment plan that’s right for you.
Suggestions for Easier Saving
Start small
Saving for retirement is not an “all or nothing” proposition. Start with a small percentage of your salary with the goal of increasing it each year. In fact, saving a small amount and starting early can make you just as well off as those who start later and save more. In the example above, Joe would have to invest over 8% of his income per year to catch up to Jane even if she continued to invest only 5% each year.
Take advantage of employer-sponsored 401(k) plans
Most companies offer some sort of plan (typically a 401(k)) that allows employees to save money for their retirement. 401(k)s offer the benefit of pre-tax deductions. This means that the money you contribute is not taxed before it is deposited into the account, thereby lowering the total amount of income tax you pay. Some employers will match employee contributions to their 401(k) plans up to a certain amount. If your employer offers matching, contribute at least enough to get the full benefit of the matching contribution. If 401(k) plans are not offered where you work, you can open an Individual Retirement Account (IRA) which will give you many of the benefits of a 401(k). Most banks and financial services companies offer IRAs.
Save your bonus for a rainy day
You earned it. Now let your money to work for you. If you get an annual or year-end bonus, invest it in an index fund, certificate of deposit (CD), or an interest-bearing bank savings account. Even if you withdraw the principle before you retire to make a down payment on a home, go back to school, or use it for a child’s education, leave the interest in the account. Allowing the interest to continue to grow until you reach retirement can give your savings a boost.
