It is common to receive advice to put money into savings, but many people do not know where to go from there. It is important that the money you are saving has a specific purpose so you can find the best way to make that money grow and begin building wealth. Understanding the purpose of each kind of savings and investment, along with the best timing of each, can help you know how to prioritize as you begin to put money away.
Before you become focused on saving money, make sure you first get out of any consumer debt. The interest rates on credit cards and most other loans are much higher than what you can earn on typical savings accounts.
Save for Emergencies
Most of the time, your first priority should be saving up an emergency fund of three to six month's worth of expenses. As soon as you have enough to put into a money market account or a certificate of deposit, do so, as it will earn more interest that way. Since this money is your emergency fund, it should be easy to access if you need it.
Your emergency fund should be used for serious financial events such as losing a job or dealing with an unexpected medical expense. For things such as home and car repairs, create a separate budget and set aside that money outside your emergency fund. If you are a self-employed person or a single-income household, you may want to have closer to a year's worth of expenses saved. This will give you more of a cushion if you were to be laid off.
Focus on Retirement
Once you're at least making progress with your emergency fund, you can work on saving toward retirement. A financial advisor can help you decide how much to start putting away, but 15% of your income is a good target to work toward. You can build up to this gradually as you get raises and pay off student loans.
Contribute up to your employer's match into your 401(k), and then you can max out a Roth IRA. If you still have more to contribute, go back to your 401(k). Your contributions will add up over time.
When you are younger, you can choose more aggressive investment options for your retirement accounts, but it's a good idea to switch those into more conservative options as you get closer to retirement.
Work Toward Other Goals
After you have your emergency fund and a growing retirement savings, then you can begin saving for other goals, such as a car, a down payment for a house, or vacations. By saving up for these purchases, you will save money on interest and free up more of your income so you can do what you want. You can track how much you have in each savings category so you know when you've reached your goals.
The priorities for these goals should really depend on your personal situation and where you are in your life. If you want to buy a new house in the next few years, then that should come first. If you are getting married soon, then saving for your honeymoon may be your top priority. It is a good idea to save up for most of your major expenses, whether it is a home remodel or a dream vacation.
Start Investing to Build Wealth
If you have more available to save and you are really interested in building wealth, you can put additional money aside each month and begin to invest it in the stock market. When investing in the stock market, it is important to think long term. Mutual funds are often the preferred way to invest because they spread the risk over several different stocks. Many brokerage firms allow you to purchase mutual funds without a high initial investment if you are willing to do automatic contributions each month. Look for funds with a good growth history.
As you work to build wealth, it is important to have goals in mind for this money, too. It may be retiring early, being able to help your children through college, or purchasing a vacation home. You may want to leave a good inheritance to your children.
Each individual will have slightly different priorities, but no matter what those priorities are, retirement and your emergency fund will come first. After that, you can focus on your other goals and building wealth. Once you determine your priorities, you can create a chart or excel sheet that lets you track your progress on your goals. Having a solid plan in front of you will make it easier to stay on course.
The Balance does not provide tax, investment, or financial services and advice. The information is presented without consideration of the investment objectives, risk tolerance, or financial circumstances of any specific investor and might not be suitable for all investors. Past performance is not indicative of future performance. Investing involves risk, including the possible loss of principal.