I often get questions from clients around establishing the fundamental basics for creating a savings plan prior to getting focused on investments & asset allocations. While this conversation is greatly impacted by personal attributes and circumstances, I do believe there is a good foundation to start with and then tailor accordingly. Here are some tips to get started, and then please schedule a consultation or financial planning meeting to refine according to your personal situation and goals.
Set a budget framework (at a minimum)
The key here is to at least understand what is coming into & out of your checking account each month. Without having a clear understanding of how much your are spending, and hopefully saving, each month you will be unable to create a sufficient plan of how to allocate each extra dollar earned. You can use online tools such as Mint to assist with this or as a client of Pearson Investment Management, LLC. you can use our online financial planning portal.
If you’r not the type to track each dollar on a monthly basis, I hear you. At least target using a rule of thumb of 50/30/20. This budgets 50% of income to needs: necessities such as utilities, mortgage/rent, childcare, etc. 30% for wants: vacation, shopping, etc. And 20% for savings, investing, paying off debt. So if you can remember 50/30/20 = needs/wants/savings then you’re off to a much better start than most!
Build an emergency fund
Unplanned expenses will creep up - it’s matter of if, not when. I personally recommend having at least 3 months worth of bills saved up in an emergency fund but this can vary depending on your health, ability to find another job, and age. These funds should be in an online savings account (more on that below) or a conservative & liquid investment account. An alternative is maintaining a credit card carrying $0 balance that can be used instead of an emergency fund or until you build up a sufficient emergency fund.
Maximize your Savings return
Now a days the local bank or even the largest institutional banks are paying around .25% on savings account. In real returns, after inflation, your money is losing purchasing power. Why keep your hard earned cash in an account that will result in real losses? Don’t do it! You can find multiple online savings accounts that are FDIC insured and very reputable that offer 2 - 2.5% APR at the moment (April 2019). I personally use Ally and recommend them. I also use a smart-saver investment account that currently yields this amount but will fluctuate more as treasury yields increase & decrease over time. I manage some of these same smart-saver accounts on behalf of clients as well.
Automate your savings
This is the single-handed best way to ensure you are paying yourself. Whether it is your 401k contributions, deposits to savings, or deposits to other investment accounts - automating these deposits monthly according to your budget prevents you from slipping on paying yourself or getting off track of your savings & investment plans. Automated deposits are easy to setup on any of your accounts so just reach out if you face any issues. Paying yourself should be a painless endeavor and keeps additional funds out of sight & out of mind to help avoid reckless spending.
Start now
Whether is is interest from your savings accounts or returns on your invested capital, the sooner you start the more money you can earn. We can control how much we save or invest, how conservatively or risky we chase performance, but we cannot control that important variable of time. Compounding is referred to as the 8th wonder of the world. Compound interest is the interest that an investor gets, not only on his original investment, but also on all of the interest that his investment earns over the term of the investment. Think of compound interest as being interest earned on interest. This creates a snowball effect over time where a small amount of principal compounding over a period time can result into a significant balance!