Figuring out where to save and how much to save for your future goals is one of the most confusing things ever. Which sucks, because it’s also one of the most important things ever. I still find strategies for saving confusing, but I’ve been trying to do a lot of research on how much to save, where to save, and what things you should consider when saving for retirement (or other long-term goals) and hopefully some of my research will help make things a little easier for you.
Figure Out What You’re Saving For and Why
Before you can determine where to save and how much to save, you need to establish what you’re saving for and why. Do you want to save for a trip? A house (if so, see my advice here)? Retirement? A Theragun (those things are expensive!)? And are you saving for that thing because you’re genuinely excited about it or because you feel pressured to abide by social norms?
It can be easy for us to have vague savings goals or to feel like we need to put a chunk of money aside in savings without having a clear sense of what we’re saving for or why. However, if we’re not clear on our goals, it makes it much easier to dip into our savings whenever we have short-term wants because we haven’t gotten excited about our long-term goals. As a result, our savings can feel more like a place of deprivation and self-restraint than excitement and growth.
It is therefore important for you to outline what you want in detail and why you’re excited about it. If you want to save for a trip, where do you want to go? For how long? What do you want to do? If you are saving for retirement, when do you want to retire? What do you hope to do during retirement?
Outlining specifics helps you get excited about the goal and have a better sense of how much you need to save and your timeline. When you are tempted to draw from your savings, you’ll hopefully have a clearer and more exciting motivation for resisting that temptation than if you had a vague sense that you want to take a trip next year or retire in 20 years (if you’re interested in creating a budget that will also help you towards your savings goals, check out this post).
Figure Out When Your Saving Goal Is Happening
Many of us have multiple savings goals that can be classified as short-, medium-, and long-term. For example, you might be saving for a trip that you’ll take in the next year (short-term), a down payment on a house that you’re hoping to buy in the next 5 to 10 years (medium-term), and retirement, which you hope will be about 30 years away (long-term).
Where to save your money will vary wildly depending on your time horizon. For example, if you will need money for your savings goals in 5 years or less (some people say 7 years or less), you’ll want to put your money somewhere safe and reliable where it is not likely to drop in value unexpectedly. For longer-term goals, you’ll want your money in a place where it grows over time so that it beats inflation. Otherwise, you are progressively losing money (in terms of value) and when it comes time to retire or purchase that large item, you might not have enough to cover those higher costs.
If you have a sense of when you will want to spend your money on something and a sense of where you will put your money (and so what kind of interest you will earn on it), you can work back to figure out how much you need to save each month to reach that goal. Nerdwallet has a great calculator for figuring that out without having to crunch annual interest rates.
Figure Out Where to Save
As I just mentioned, for short- to medium-term goals, it’s often considered best to put your savings in a place where they can grow safely and reliably. These places include high yield savings accounts, money market funds, CDs, and some types of government bonds. So, what are each of these things?
High Yield Savings Account (HYSA)
- HYSAs return considerably higher interest on your savings accounts than conventional savings accounts. Ally is one of the most popular examples of a HYSA and, as of November 2022, has a 2.75% interest rate on savings accounts. Compare that to many other banks that maybe have a 0.1% interest rate. 2.75% might sound like small potatoes, but if you have $10,000 in a savings account, that will yield you $27.50 each month in interest! And these are just like regular savings accounts—they are just as safe as other saving accounts and you can easily move the money to and from other banks and into checking accounts. For a list of HYSAs, see Nerdwallet’s list of best HYSAs as of November 2022.
Money Market Funds
- Money Market Funds are another kind of bank deposit that pays interest based on prevailing interest rates and, similar to HYSAs, usually pays considerably higher interest rates than conventional bank accounts. There are usually minimum requirements for how much you deposit and you should always look for an FDIC-insured account to make sure you are protected from losing money. These accounts tend to be very safe and have few restrictions on withdrawing money.
Certificates of Deposit (CDs)
- CDs are time deposits. Basically you deposit money in a bank for a fixed amount of time, usually anywhere from 3 months to 5 or more years. Because you agree to give the bank that money for a fixed time, they often pay a higher interest rate than even HYSAs (depending on the time horizon) and that interest rate is fixed. There are penalties for withdrawing early, however, unless you purchase a No Penalty CD.
Government Bonds
- Government Bonds are basically a way for individuals to loan money to the government to help fund government spending. Treasury Bonds (T-Bonds), I-Bonds, T-Bills, and T-Notes are considered very safe as they are backed by the U.S. government. They generally return far less than the stock market, but more than HYSAs or Money Market Accounts. There are also often few restrictions on getting your money (though you must keep your money in I-Bonds for 1 years and if you withdraw before 5 years you lose 3 months of interest).
Investing in the Stock Market
For longer-term goals, these assets rarely cut it because they virtually never beat inflation. In fact, the interest rates we’re currently seeing on things like I-Bonds and HYSA’s (as of 11/16/22) are only as high as they are now because inflation is so high. A year ago, inflation was lower and HYSAs were offering 1% or less of a return—still really good in comparison to non-HYSAs, but they are (probably) never going to offer more than the inflation rate. The only asset class that has reliably beat inflation over time is stocks.
This is why you generally want more of your money in stocks for longer-term goals. If your money doesn’t equal or beat inflation, then, in real terms, you are just losing money over time. Not good if you want to have a comfortable retirement—or any retirement.
If you, like me, find the stock market to be a terrifying place that feels like the Wild West—risky and unpredictable—never fear. Over the long term, the stock market has been extremely reliable—both in terms of there being consistent downs, but more consistent ups. For example, over the past 30 years, the stock market has returned over 7% on average after adjusting for inflation. Additionally, over the past 20 years, the stock market has declined by 10-20% once every two years on average (a decline that’s called a stock market correction). So that 7% return is after inflation and after a large number of downturns.
The Which (As In: Which Stocks Do I Pick?)
This is why the stock market is such a good choice over the long term. However, this does not mean you need to become an expert in picking individual stocks. In fact, you almost definitely should not do that. The most reliable (and generally cheapest) way of making money from the stock market is to invest in an index fund—basically a basket of investments that mimic a particular market like the S&P 500. For a detailed guide on investing, see this post.
The Importance of Diversification
To continue with the S&P 500 example, most of us do not have enough money (or time or interest) to buy a share in every company in the S&P 500 and rebalance whenever companies enter or leave the S&P 500. Index Funds allow you to have fractional shares in all of the companies in a particular index and it rebalances for you as companies enter or leave.
This means you are very diversified, your performance tracks the market, and your costs are much lower because you don’t need a portfolio manager to handpick stocks. On top of it all, only 26% of actively managed funds beat out index funds in terms of returns. And it is even rarer for funds to beat the market over the long-term.
Target Date Funds: The Easy Option
To make it even easier, many investing companies have Target Date Funds (TDFs) which let you estimate the year you will retire. Target Date Funds automatically reallocate your invested money towards safer assets (like bonds) as you approach retirement. Many TDFs are frowned upon because some companies use them as a dumping ground for underperforming assets (one of my favorite podcast hosts on Stacking Benjamins compares them to a Sunday buffet breakfast where all of the leftovers that haven’t been eaten are hidden in the Sunday buffet). Some financial advisors also believe that they become too conservative too fast, leaving you with less money than you want for a comfortable retirement.
For the former issue, Vanguard’s TDFs are generally considered well-performing and reliable and they invest in Vanguard’s broadest index funds. For the latter issue, you might consider choosing a later retirement date than when you actually plan to retire. If you are okay with a little added risk, this means more of your assets will be in stocks for longer (and so likely returning a higher rate).
A Warning About Stock Picking and Speculative Assets
If you are super interested in the stock market and want to buy individual stocks, then go for it! Just make sure that you are viewing that money as “play money” that you are okay with losing. Likewise, if you want to invest in a speculative asset like cryptocurrency then go for it, but again, that should be play money. Many respected financial experts compare putting money into cryptocurrency to gambling because cryptocurrency is a speculative asset, it has no intrinsic value and its value is based purely on supply and demand.
What “Vessel” You Should Use
A last important point of consideration for retirement savings is what “vessel” you put your retirement savings into. By that I mean, do you put your retirement savings in a 401K, IRA, Roth IRA, or some other variation? These terms are considered retirement “vessels” because they are ways of packaging your retirement savings. They are not reflective of how much money is in your retirement account or how that money is invested.
401Ks and IRAs are pre-tax accounts—the money you earn is put into these funds before taxes are taken out, though that money is later taxed when you take it out for retirement (presumably years later). Roth IRAs are post-tax accounts. That means you add money to those accounts that has already been taxed and that money never gets taxed again.
Should I Pick a 401K, Traditional IRA, or Roth IRA?
How do you know which to pick? Presuming you have an option, you should pick Roth IRAs if you anticipate being in a higher tax bracket when you need that money. For most of the population, that is a good bet. For one thing, we probably will be worth more as we get older. Even if we are making less money, many financial experts believe that taxes will only go up over time.
Taxes may seem high, but they are historically and in comparison to other countries in the world, extremely low. And yet, US debt is quite high. Taxes are one way we pay down that debt and so they’ll likely have to go up at some point.
However, if you think you will be in a lower tax bracket when you are older, then you should consider the pre-tax accounts. For more information on this, see my post on investing for retirement and retirement vehicles. If you’re unsure, having a mix of accounts could be your best bet.
How Much to Invest for Retirement
In fact, that could be a good option for another reason as well. General recommendations are to save 15% of your annual income towards retirement (employer contributions count towards that percent).
To use myself as an example, my employer lets me contribute 5% of my pre-tax income to retirement with an employer match. That means I’m 5% short of the 15% retirement. To make up for that, I have a personal Roth IRA where I contribute an additional 5% of my income. That way I meet the retirement target and am diversified in my pre- and post-tax accounts.
And one last thing that is potentially one of the most important things—if you are contributing to an employer-sponsored retirement plan, make sure you have picked (or your employer has automatically picked) an investment vehicle for that plan. There are stories of employees putting a percentage of their check each month into their 401K thinking that they have invested their money, but they didn’t realize that they needed to choose an investment for that 401K to then funnel money into.
When they went to retire, they couldn’t actually retire because all that money they saved was never invested, never grew, and was way too paltry to live on for more than a few years. That’s super shitty, so familiarize yourself with your retirement plan and make sure that isn’t happening to you. It is the rare person who wants to work when they’re 80, let alone really want to work, you know, in their actual earning years.
Take Home Points
That was… a lot. To summarize, you should:
- Reflect on what you want to save for and why you’re saving.
- Next, determine whether your savings goals are short-, medium-, or long-term and decide where to put your money accordingly.
- Short- and medium-term goals should involve putting your money in safer assets like HYSAs, CDs, or money market accounts.
- Long-term goals require you to think more carefully about beating inflation and the only assets that has consistently beat inflation are stocks.
- Sidebar, real estate can be a good investment too, but we often neglect the maintenance costs, closing costs, taxes, time-related opportunity costs (you spent time fixing things you could have spent on other stuff) and more that go into real estate. Once you factor in all of those phantom costs, it’s often a less ideal investment than people make it out to be. That’s not to say it’s a bad investment, it can be a great investment! But unless you’re pretty savvy with real estate and are okay with investing a lot of time in becoming expert in this area, you should buy a house because you want a house and plan on being in it for a decently long time (most often people say 7+ years), not because you think you’ll make money on it.
- For retirement savings, decide on your investment vehicle—a 401K, IRA, Roth IRA, etc.
- Use a savings calculator, your time horizon, and the interest rate you expect to earn on your savings to determine how much you need to save each month to meet your goal and, ideally, automate that saving so you don’t have to think about it. If you’re scared of automating savings, and not having enough in a given month, put a monthly reminder in your phone to save X amount and, in months where it’s feasible, set that money into your savings.
Finally, remember that I am not a financial advisor so before making any money decisions, consult with a professional.
Do you have any other tips or suggestions? Let me know in the comments! And if you enjoyed this post or think it would be helpful for others, please consider liking, subscribing (in the sidebar), or sharing.