You have your financial goals set, you are ready to start building up your savings but you have one problem – you don’t know where to save your money. Not to worry here is a quick guide on where you should put your money for the five most common savings goals, and where not to put those savings.
An emergency fund should be safe and secure and ready for you when you are in need. That is why it is called an emergency fund! Thus you want your savings for emergencies to be in a savings account or money market.
You do not want your emergency funds to be in the stock market nor do you want to rely on a credit card! The stock market goes up and down and you need to be able to depend on a set dollar amount for your emergency funds. Using a credit card to manage your emergencies is unwise as it puts you in debt and makes your emergencies more expensive, which throws off your whole purpose of savings.
When you are saving for a near term purchase such as a car, vacation, wedding or other big item you want this money to be safe and ready when you need it, just like the emergency fund. Therefore you should put it in a savings account or money market also. In fact a great way to easily save for these items is to set up an automatic transfer from your checking into a savings account set up for your goal.
You do not want to “save” for these items by taking out a loan or putting it on your credit card. Buying depreciating assets and experience items on credit makes them cost more in the long run which means you have less money to actually accomplish your goals. Instead save up for these items and enjoy the freedom of only paying what each item actually costs.
This one is a bit trickier as it depends on when you plan on buying your house.
Less Than 3 Years: If you are planning on buying a place within three years you will want to keep the funds in a savings account or you could use CD’s to get a bit higher return. Yet again the importance here is making sure you have the funds and not on getting high returns in the market. The market can go down and if it is down when you are ready to buy your house you won’t have as big of a down payment as you wanted, causing you to buy less house or take out a bigger mortgage.
Less Than 5 Years: This one is a bit trickier because you are close to needing the money but you do have some time to ride out the waves of the market. I actually put this in the category of your personal preference. If it would stress you out too much that the money might go down in value then stick with savings, however if you are okay with taking on a bit more risk you could put a small percentage in bonds or a stocks mutual fund.
How much could you put in the market? I would recommend staying between 30 – 50% in the market and the remainder in a savings account or CD. Slowly start moving the money to savings as you get closer to your buying time. Remember even the bond market goes up and down and is only considered “safe” because it has smaller swings than the stock market.
In Between 5 – 10 Years: This is the range when you do have a bit more flexibility to add more asset allocation to your savings plan. Again this is going to depend on your preferences but the closer you are to 10 years the more you can have in the stock market, then slowly as you approach your target purchase date to move to the less risky allocations.
Try to focus on high quality less risky stocks; this is not the money to be betting on a tech startup! You might consider some index funds to keep costs low and not have to worry about stock or bond picking.
You do not want to save for your house by taking out a 100% mortgage, I am not really sure you can even do this anymore but if you find you can – don’t do it! Also like I said earlier don’t pick investments that are too risky, after all the goal is to eventually be able to put a down payment on a house and move in!
My preferred place to save for your kids’ college would be in an Educational Savings Account (E.S.A.). While the contribution limits are low it does offer you the most flexibility in where you can invest the funds and gives you the added benefit of being able to use it for private school before college. While using the 529 allows you to save more, you have a lot less flexibility, and you can only use it for college. For more information on ESA.
You do not want to save for kids’ college in a pre-paid plan. This is where you pay your child’s tuition to an instate school at today’s rates. This is bad because it restricts where your child can go, but it also locks you into your rate of return being the rate that tuition increases.
This is my favorite one. Retirement savings is easy because I recommend you save everywhere! The more you save the better, so utilize everything that you have at your disposal. These include: 401K’s, IRA, ROTH IRA and even taxable accounts. Try and first max out any of your tax favored accounts and then move on to the taxable accounts. It is more important to just start saving for retirement than in which retirement account you are going to save in. Don’t become paralyzed from action by worrying about which one is perfect, just get to saving!
You do not want to save for retirement by relying on the government and social security.
One extra place that you can put your “savings” is on to your debt! When you pay off your debts you free up money to do some real lasting savings. Get those credit cards out of your life and you will quickly have money to save for retirement, college, cars, emergencies and houses.
Now that you know where to save it is time to get saving.
Want a bit more help? Check out my one on one financial coaching.