How to Maximize Your Investment Savings
The Investment Savings Hierarchy
If you’ve ever wondered if a penny saved today will really be worth a lot more than a penny saved tomorrow, then take a look at this simple math:
- If you put $1 away at age 20, that dollar would be worth $21 by age 65, assuming an average 7 percent return over the years.
- If you wait until 30 to invest that same $1, it will be worth $10.68. Start at 40 and you will have $5.43.
- Wait until you turn 50 to invest that same $1 and you’ll get a measly $2.76.
So a dollar invested at age 20 is nearly twice as productive as a dollar invested at 30, and 7.5 times as powerful as a buck that gets put to work at age 50!
Hopefully, you have already started saving and if you haven’t, then the time to start is today. Every day that you wait is costing you serious money.
Keep in mind that you need to have a plan to maximize your return. A great blueprint for optimizing your savings is the Hierarchy of Investment Savings which outlines where to put your money and in what order.
Hierarchy of Investment Savings: From Top to Bottom
Level 1: Emergency Cash Savings
At the very top of your hierarchy or pyramid of investment, savings should be your emergency cash savings. The amount of emergency cash on hand should be able to cover 3-6 months of fixed expenses and should be held in a money market account, a high-interest savings account, or in other very liquid investments. Use this money only for true emergencies, such as job loss or catastrophic medical costs.
Level 2: Short-Term Cash
Your next level is for short-term cash which should cover expenses coming due in 1-3 years. This should not be confused with emergency savings; this money should be used if you have a known large expense coming up in the next 12 to 18 months, like a down payment on a house or a new roof. It doesn’t make sense to have your emergency fund wiped out due to a planned financial event, even if it’s a year or year and a half away.
Level 3: Match Your Employer’s 401(k) Contributions
Now it’s time to match your employer contributions. You’ll want to contribute what your employer is willing to match for free to your 401(k).
Level 4: Roth IRA
Next, start funding- and try to fully fund- a Roth IRA. Contributions are made with after-tax dollars and can be withdrawn at any time. Just be sure to understand how much you can take out without incurring a penalty. Once you reach 59 ½, all withdrawals are tax-free. Additionally, unlike a traditional IRA that requires minimum withdrawals at age 70 ½, there is no mandatory distribution age with a Roth IRA.
Level 5: Max Out Your 401(k)
After funding your Roth IRA, go back and max out your 401(k) if possible. In 2016, the maximum contribution is $18,000. If you can put away $18,000 each year with the hopefully added benefit of your employer’s matching 401(k) program, your money will build up quickly.
Level 6: Taxable investments
If you have done all of the above and still have money to save, you can put those funds in a brokerage account. Whether you manage your money or have someone else manage it, be sure that you are in a well-balanced diversified portfolio that will earn dividends, interest, and distributions.
The Balance does not provide tax, investment, or financial services and advice. The information is being 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 results. Investing involves risk including the possible loss of principal.