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One of the most frequent questions we get is “What do I do with my savings?” As in, “I’m trying to diligently save money, but do I keep it in retirement accounts or my savings account or stocks and bonds or what?!”
That’s a hard question to answer because everyone’s priorities and situations are a little different, but thanks to my unbeknownst-to-him financial hero, David Bach, we have a simple framework that can help everyone.
If you don’t know David Bach, he’s the brilliant author of several bestselling books, including the life-changing Smart Women Finish Rich. No joke, this book changed my world. If you’re at all interested in a simple, do-able approach to personal finance, it’s a must-read! In Smart Women Finish Rich, David (yup, we’re forcing the first name basis) talks about his grandma’s “3 basket approach to saving”. Grandma Bach would divide her savings each month between three distinct investment account “baskets” which is adorable for a grandma, but in keeping with our wino theme, we’re going to change baskets to barrels:
- Emergency Savings Barrel
- Retirement Savings Barrel
- Dream Savings Barrel
Your Emergency Savings Barrel
What would happen if you lost your job tomorrow? How long could you support yourself while you looked for a new job? About 55% of Americans live paycheck-to-paycheck (source), meaning that they NEED their next paycheck to pay their upcoming bills. Not only is this a needlessly stressful way to live, but it can be dangerous! In uncertain times, no one’s jobs are guaranteed. You may find yourself needing to live without a paycheck for a few weeks or even months. Not to mention all the expensive things that can go wrong at any time! iPhone dropped in the pool, car trouble, family illness, ugh!
And my goodness, it is embarrassing to ask mom or dad for money when you’re over like 25. It makes you feel like the Baby Boomer’s version of the “typical millennial”, running back to your parents because you can’t support yourself. This is where your emergency savings saves your tush.
A good rule of thumb is to put 5% of each paycheck into your emergency savings until you have 3-6 months’ living expenses saved. More if you’re in a volatile industry or you’re an independent contractor with varied income.
You need this money to stay liquid (financial speak for “easily accessible”) so you can get to it when you need it with very little notice, cause, you know, emergencies don’t like to give you a heads up. Best way to ensure liquidity: savings account. The trick, then is to make yourself forget it’s there unless an actual emergency comes up.
Your Retirement Savings Barrel
As we discussed in The $831,751 Reason to Save for Retirement While You’re Young and Broke, it is vitally important to start saving for retirement as early as possible to take advantage of compound interest. The government actually limits the amount of money that you can put in your retirement fund each year (they don’t want you taking too much advantage of these awesome tax breaks), but most people never get anywhere near that max until they hit 45 or 50 and realize, frick, I don’t have nearly enough for retirement, I need to start saving every spare dime to my retirement account. Don’t be that person!
Your mission: max out the retirement account of your choosing by saving as much as you’re legally allowed each year. The max is currently $5,500 for IRAs. The max for 401(k)s is $18,000/year, but that’s a lot! If you’re under 35, $5,500/year should give you a solid retirement savings. If you’re older, you are closer to retirement, you should consider saving more in your 401(k). Not familiar with these retirement accounts? Check out our 3 Easy Steps to the Retirement of Your Dreams.
How am I supposed to save $5,500/year?
$5,500/year ($458.33/month) may sound high, but don’t let this goal deter you from starting TODAY with whatever you can. Then you can build to the max over the next few years. Start with 5-7% of your income today and select the option to automatically increase by 1-2% each year. You’ll never miss 1% less of your paycheck!
There are a couple ways to painlessly increase your retirement savings as you go:
- Increase your percentage every time you get a raise. You’re already ok living without that money, so you won’t miss it.
- Once your emergency barrel is full, add that 5%/month to your retirement barrel instead. HUGE boost to your retirement savings without any extra effort!
- If you’re using the Champagne Waterfall Strategy to pay down your debt, you’ll have that monthly waterfall money available once all your debts are paid off, and you can roll that into your retirement savings. Again, you’re used to living without that money, so you can hugely improve your finances without feeling any extra pinch!
Your Dream Savings Barrel
Now to the fun part: saving for your dreams!
My first-ever savings dream was a trip to Paris. I was making $12/hr as a receptionist, and my husband was making $9/hr part-time at Home Depot while he went to school. Thousands of dollars for a week in Paris seemed unreachable. But I committed to saving just 2% of my paycheck (all we could reasonably afford) for this really special purpose. Six years later, J and I were taking in the view from the top of the Eiffel Tower!
What are your dreams? Travel? Starting your own business? Buying a house? Sending your kids to a good college?
How much do you think it will cost to realize your dream? If you saved 5% of your paycheck in this Dream Savings Barrel, how long would it take you to come up with that money? For the math-impaired: take your monthly pay times .05 to see how much you’d be saving each month, then divide the cost of your dream by that monthly savings amount to see how many months it would take to save up for your dream.
You can play with the numbers til you find the solution you’re most comfortable with. What if you just saved 2%? What if you could save 7%? Find what works for you.
Where to keep your Dream Savings
Now what do you do with your Dream Savings? DON’T mix them in the same savings account as your emergency fund. Open a new account for Dream Savings. What kind of account? Well, there are about a million and a half ways to do this. So instead of bog you down with your million and a half options, we’ll lay out two simple options.
Money Market Accounts
Money Market Accounts (not to be confused with money market funds, which are something different): Money market accounts are awesome! You can think of them as a slightly more sophisticated savings account.
Money market accounts offer better interest yields than savings accounts, they are insured by the FDIC, and you can still access your money relatively easily. Most require that you keep a minimum balance in the account. After all, if the bank is going to pay you better interest, they want some assurance that you won’t pull out all the money at once. Usually, the higher the minimum balance, the better the interest rate.
It takes a little shopping around to find the best account for you, but Nerd Wallet has already reviewed over 60 money market accounts and picked the best options for you (love Nerd Wallet for that!).
Certificates of Deposit (CD’s)
If it’s going to take you awhile to realize your dream, you might want to consider buying CD’s. Here’s how they work: you buy a CD for a set amount of money and agree that you won’t cash it in for a certain amount of time.
For example, you can buy a $500 5-year CD, earning 2.3% interest. So at the end of the 5 years you get your $500 back plus all that interest. Generally, the more money you invest and the longer the holding period, the better the interest. So if your dream is more than 3 years away, CD’s can be a better option than money market accounts.
The fact that you can’t use your money until the maturity date (without serious financial penalties) may sound like a negative. But it can be good because it forces you to stay out of that money until it’s grown.
Like with money market accounts, you want to do some comparison shopping for the best rates. Thanks to Bankrate.com for doing the hard work for us and coming up with a list of the best rates 🙂
What about Stocks and Bonds?
Stocks and Bonds are risky. They take a lot of research, and are really susceptible to changing market conditions. If you’re interested in finance, they can be really fun and exciting. But if you’re looking for financial solutions that don’t invade your life, we recommend sticking with the low-maintenance, steady-return money market accounts and CD’s.
If you are interested in learning about stocks and bonds, leave a comment!
Three Barrel Recap
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Post your dreams in the comments!