Saving money is important because it allows us to meet financial obligations when it comes to unexpected emergencies and to prepare for a more comfortable retirement. The act of saving alone will not create wealth and that is why it is crucial to be disciplined and have a plan to turn your savings into wealth .
Set Realistic Spending Reduction Goals
Lets say you spent $250 dining out last month and have identified this as one of your budget items that you are determined to reduce. In order to be successful you want to set a realistic dollar amount to cut spending by 10% is a great place to start and in this example would mean reducing the amount spent on dining out by $25 per month, an amount I think you’ll agree is obtainable without too much sacrifice. Now unless you are eating 4 meals each day, the money saved by cutting out one fast food meal will require you to eat at home so make sure that you account for that in your grocery budget.
Automate Monthly Savings Transfer
The single most important task in turning savings into wealth is to invest those dollars before you have a chance to spend them. Sounds simple doesn’t it? As we all know it is not that simple. Unless you keep your cash under your mattress, I hope you don’t, you can setup a monthly transfer from your checking into your savings. You can start small with a $25-$50 transfer each month and increase it down the road to match your savings goal. The important thing is to set a transfer amount that you can realistically meet each month and leave it alone.
Invest Only After Establishing Emergency Fund
To create wealth you need to 1) save more than you spend 2) Invest those dollars in the equity markets and 3) minimize the amount of debt you carry. Most people get into debt because the don’t earn enough income to support their lifestyle, have impulsive spending behavior, or don’t have a sufficient emergency fund. I’m sure you have read that a typical emergency fund should cover your living expenses for 3-6 months. Today’s economic situation is not typical and the US Bureau of Labor Statistics reports that the average duration of an unemployed worker is 40 weeks. Depending on the amount of your severance package, a 6 month emergency fund would not be sufficient to cover living expenses for the average unemployed worker and as you can see an 8 month emergency fund is closer to reality. There is no doubt about it, the economic changes over the last 5-6 years have caused financial challenges to Americans that will impact our standard of living.
What are the Options for Investing My Savings?
If offered by your employer, you can fund a 401K up to the maximum of $18,000 per year ($24,000 if age 50 or older). At a minimum you should invest enough to qualify for the employer matching contribution. Another option is a ROTH IRA which is funded with after-tax contributions and has a contribution limit of $5,500 per year, with a catch-up limit of $6,500 for those 50 or older. A benefit of the ROTH is that unlike an employer-sponsored plan or traditional IRA, you don’t need to take a minimum distribution after age 70 1/2. Funds can be left in a ROTH IRA to grow as long as you like. A traditional IRA has similar limits as the ROTH except the traditional IRA is funded with after-tax contributions.
So now that you are saving money each month and you’ve decided which type of investment is the best option, you need to transfer the money to a brokerage account. If you are eligible, your employer can set this up for you or you can contact a brokerage like Vanguard directly. Once your investment account is established you can have a fixed dollar amount transfered from your bank account monthly and you can increase this amount to match your increased savings.