3 Reasons You Should Start Saving NOW and How to Get Started
REASON #1 Risk Management
Too many of us were not prepared for COVID. It has been suggested that setting aside 3-6 months of living expenses should be done to prepare for an emergency. Considering the way the year 2020 went down, setting aside one full year of living expenses for an emergency is not a bad idea. There may not be another COVID pandemic, but how long could you cover your basic living expenses in the event you became disabled and unable to work a job?
Don’t have a lot of money? Start where you are. Track your spending over 3 months and create a spending plan, or budget. After reallocating some of the money you spend on your desires and consolidating debts where it is appropriate to do so, if you are not in a position to pay yourself first, consider “microsaving” using money saving apps like Acorns or Chime. A little goes a long way over time, if you remain consistent with your effort. There are many options available and each has its own set of pros and cons so you will have to do some research to determine which app is right for you.
REASON #2 Compounding
Depending on what you are saving for there is a reward for starting early, and there could be a cost to waiting. Compounding refers to the way the value of an asset increases over time. With compounding, interest is earned on both the amount of money you pay into the account – the principal amount – and the accumulation of the interest earned on the account.
Consider a 30-year-old saving $2,000 each year in an account earning an annual 7-8% rate of return. By age 60 this account will have grown to approximately $245k. If this same individual decided to hold off on saving until age 32, by age 60, that account would only be worth approximately $206k. That 2-year waiting period cost that person about $39k.
REASON #3 Inflation
Most people understand that saving is important, but HOW you save is also important. Inflation measures how much the cost of goods and services rise over time. The rising costs mean your dollar won’t buy as much as it did before; your purchasing power has decreased.
Let’s look at how inflation works. You have $100 in a savings account which pays an annual interest percentage of 1%. After the interest is paid you will have $101. That’s great, but if the inflation rate is 3% your purchasing power has decreased even though you are $1 richer. You would have needed $103 dollars to keep the same purchasing power as before. Because of inflation, short term (less than 2-3 years) savings like an emergency fund may do well in a traditional savings account, money market account, or a shoe box underneath your bed. Saving for goals that are 3, 5 and 10+ years down the line may require a more sophisticated effort.
You may also have multiple savings goals that overlap. Savings buckets can be helpful for tracking your progress in achieving each goal. This is often referred to as the “envelope method” but may be performed digitally if you contact your financial institution.
High-yield savings accounts and Bank CDs may credit a higher interest rate, however with CDs you won’t have access to that money for a predetermined amount of time and you will be locked into the interest rate even if inflation and/or interest rates rise. Additionally, early access to your funds in an emergency will come with a fee.
How to Get Started
Once you have determined what you will save for, consult your spending plan for how much you will save and the time frame it will take to reach your savings goal. Here are some ways to get started with a stress-free savings:
- Make it easy on yourself. Use direct deposit or some way of automating your savings. Arrange to have money taken directly out of your paycheck and placed into a separate account, or plan for a certain amount to be transferred from your checking account into your savings. You can schedule transfers for payday or another specified day of the month.
- Consider an appropriately timed certificate of deposit (CD). If you have a lump sum of money that you will not need for a few years and do not like the risk associated with higher gains in the stock market, consider a CD, high-yield-savings account, government bonds or treasury bonds.
- Expense elimination and debt consolidation. Eliminate unnecessary expenses such as subscriptions that you don’t use often – or at all – and consolidate debts where possible, if appropriate.
- Buy in bulk and buy generic brands. Next time you’re in the supermarket take a glance at the ingredients of your favorite brands and their generic counterparts. You may be surprised to find there is very little to no difference in the ingredients, taste, and/or efficacy. If you find yourself running to the store a few times a month for a specific item this could be an opportunity to reduce your spending. Buying in bulk the household items you use most often could save you money over time.
- Take advantage of high yield savings accounts and compound interest accounts. Compounding allows for a perceptible difference in account value year over year which is likely to increase the savings behavior.
- Pay off credit card debts as soon as possible. Before you charge an item, consider how long it will take to pay off the debt. Also think about the new cost once you add the interest you will pay for each month until the purchase is paid off. Is the item worth the new cost?