you can live the rest of your lives like most people can’t”
Building up a savings can be hard but definitely worth the time and discipline. Can you imagine not having to worry as much when emergencies hit, or not needing to put gifts on your charge card? Through careful planning you can avoid pitfalls.
- Revolving: This savings is designated for expenses that occur throughout the year, but not every month, for example, car insurance, oil changes, taxes, tuition, birthdays, and Christmas. Make a list of expenses that you will face this coming year, their expected cost, and the month in which they will occur. Add the expenses together and divide by 12. This will give you a figure to save each month. As the expenses occur, use the revolving savings to pay for them. It will take a year to build up this savings account. If you can put a little extra in each month it will help you to meet this year’s expenses and prepare for next year. If it is too difficult to put that much away in a revolving savings account, then take your time. It might take 2 years to build up the account but a little money saved over a long period of time is better than no money saved at all!
- It has been recommended that each household have 3 – 6 months of income in a savings account. This will help your family avoid getting into debt should there be a loss of income.
- Emergency: It is important to have money set aside for emergencies. You cannot always tell when you will get sick, injured, or even lose your job. This type of savings account can be set up at a bank or credit union. Emergency savings must be liquid (ability to access the cash whenever needed with minimal or no consequence).
- Long Term or Investing: Long term savings would be for college, retirement, or a wedding. This account could be set up in a number ways through banks, credit unions, certificates of deposit, or a number of investment engines (explained below). This type of savings is usually accumulated over a period of time and does not need to be liquid.
It may seem overwhelming at first to think that you need an emergency savings… 3 – 6 months of income set aside…but choose a type of savings and get started. You do not have to build up each savings account all at once. The important thing is to start, and then make it a habit. Here are some tips to help get you started:
Pay yourself first. Designate a percent of your paycheck to be put into savings before you even get the chance to spend it. You can have it directly withdrawn from your check and put into a savings account at your bank or credit union. This doesn’t have to be a large percentage, just what you can afford. As your income increases you can leave this percentage the same or increase it as well. It is hard to miss money you do not see!
If you might feel tempted to spend the money you are saving, consider putting it in a bank or credit union that is across town. That way you will have time to think about the purchase while you are driving to that bank or credit union to make the withdrawal.
Use paper money for all purchases. Take the change from each purchase and deposit it into a savings account once a month or save it in a jar for a special occasion or emergency cash.
Step Down Principle. The Step Down Principle will allow you to save money on the things you do every day, by stepping down from more expensive spending to less expensive spending. For example, going to an evening showing at the movie theater might cost $15 per person for a ticket, drink, and pop corn. One step down from the evening showing would be a matinee, a step down from this might be renting a movie, another step down could be checking out films from the library. The Step Down Principle can be applied to just about everything, eating out, buying clothing, entertainment, dating, even things like car insurance, and amenities in your home. Any money saved from using the Step Down Principle could be put into savings.
Before making the decision to invest, see that you have a working budget, and a savings plan for emergencies. It will not benefit you to have money tied up in an investment if you are living paycheck to paycheck or if an emergency strikes. See that your debt is under control. Hold off on investing if you have pressing debts, use the principles discussed above to reduce or eliminate your debts. It is also important to carry appropriate insurance. Make sure you are covered on health, and auto. You may want to consider life insurance if you have any dependants, this will aid them in the event of your death. If necessary, liability insurance will protect you in case you are ever sued; this would cover your assets as well as your lifestyle. Doing these things will help you be in a better position to start investing.
Time…Once you feel ready to invest, the first step is to set goals. Where do you see yourself in 5 years, 10 years, 50 years? Your goals will determine what type of investing is right for you.
Age…Younger individuals can afford to take more risks with their investments, they have a longer time to invest, making and losing money along the way. Older individuals who might be closer to retirement may not want to be as risky with their money.
Diversify… “Don’t put your eggs all in one basket!” This is one way to think of diversification. It is not wise to put all of your money into one type of investment, or into only one company. After researching the different types of investments, take into consideration your goals and make a decision on how to diversify your investments. For example you might have 2 mutual funds, an IRA, and 2 CDs.
Compounding Interest… This is where you not only earn interest on your initial amount invested, but also on the interest you have earned so far.
Time value of money… The earlier you invest your money the more you will make. Time and interest combined will help you to earn more than if you waited and invested more money at a later date. Compounding interest makes this possible.
Dollar Cost Averaging…This will help you avoid the common mistake of buying high and selling low. Invest equal amounts of money on a regular basis no matter what the price of the investment. This will allow you to buy more shares when the price per share is down and less when the price per share is high.
The Rule of 72... To find out how long it will take an investment to double, simply divide the interest rate into 72. If you have an investment growing at 8% interest it will take you 9 years to double your investment. This calculation works for any dollar amount being invested.
Keeping risk levels and your age in mind, visit with your bank or local investment agency about getting started with an investment. It is important to choose an investment agency that you feel comfortable with and agree to their terms and conditions.
1. Lower Risk Investments – these do not have the potential to produce rates of return (or earnings) as great as other higher risk investments. However, earnings are guaranteed and in many cases they are also insured.
Bonds - Bonds are purchased from corporations, city or state governments, and federal governments on the agreement that they will reimburse your money with some interest after a designated period of time. For example, you might purchase a five year bond for $1000 with a 5 % interest rate from your local government. For five years the government will use your initial $1000 for a specific project, but pay you 5% per year for that use. When the bond matures at the end of the 5 years you will receive the initial amount of $1000 and the total interest. Some organizations pay the interest yearly, others pay the interest in one lump sum at the mature date.
* There are different levels of risk with corporate and government bonds that may have a high risk level. For example, there may be the risk of a new corporation going under, thus not being able to repay the initial amount of the bond to you the investor. (Savings bonds are low risk, corporate or junk bonds are higher risk. Talk to an investment agency of your choice about which would be best for you.)
Certificate of Deposit (CD) – These are similar to bonds, but can offer a little higher interest rate depending on the length of the CD. CD’s require that you invest your money for a particular period of time, for example, 6 months, 1 year, or 5 years. There are penalties for withdrawing your money before the due date.
Money Market Account – This type of account typically offers a higher interest rate than a regular savings account. You can write a limited number of checks from this account without receiving a penalty, for example, 15 checks per year. Typically there is a minimum amount required to be in the account at all times, for example, $1000. This amount is usually higher than a savings account minimum.
2. Higher Risk Investments – these rates of return (or earnings) will be higher, but they are not guaranteed. Any statement of how well the investment will do is typically based on past performance and cannot always accurately portray how the investment will do in the future.
Mutual Fund – This type of investing has a higher interest rate, 8%, 10% or even higher. Usually the higher the interest rate the higher the risk. A mutual fund consists of a number of different stocks (diversification) that are managed by a professional who makes the decisions of when to buy and sell the stock. There are fees required because someone is managing the fund. Since the funds are diversified, one stock within your fund might loose money one month and another stock might earn money. Allow time for the money to grow (compounding interest) by keeping the mutual fund for a period of time (5, 10, 20 years depending on your investment goals) and you will increase your chances of making money. Remember, mutual funds contain stocks; you may have periods of time when you lose money as well as other periods when you earn money.
Mutual Fund Fees – Mutual funds are known as load and no load funds. A load fund has two different types, front end load and back end load. A Front end load means that a fee will be charged every time a share is purchased. Back end load means that a fee will be charged every time a share is sold. A no load fund indicates no managing fees, but this also means no manager. You would be responsible for watching the stock within the fund, and would work directly with the investment company to buy and sell the stocks. There may also be annual fees with a no load fund. Another fee, referred to as the 12b-1 fee, is specifically for promotional costs such as advertising and marketing.
Individual Stocks – Owning stock means owning a portion of a company. As an owner of stock you can buy and sell it as you wish. The value of stock is determined by three main factors, how well the company is doing, the economy, and each investor’s perception of how well the company will do. There are two ways to make money with stocks, first, selling shares once they have increased in value, and second, reinvesting dividends. A dividend is part of a company’s earnings that are paid to the owners of the stock. Some companies reward their stockholders with a high percentage of their dividends. Other companies may not even offer dividends; they will reinvest their dividends back into the company hoping to make more money. Stockholders can also reinvest any dividends they may earn. Companies as well as stockholders who reinvest their dividends usually grow faster.
Coverdale: This plan has a maximum contribution of $2,000 (yearly) and an age limit (30 years old). This plan is not taxed as long as the funds are used for education.
529 Plan: This is a state sponsored plan, managed by a private company, there are tax benefits. For example, the earnings could grow tax free if they are used for education. There are state limits concerning the amount that can be contributed.
Individual Retirement Account (IRA) – An IRA is a way to save for retirement. An IRA is not a direct investment, but within an IRA you can invest in things like stocks, bonds, and mutual funds. There are yearly maximum amounts you can contribute to an IRA. The amount will be $4,000 for 2005 – 2007 and in 2008 the amount will increase to $5,000. This amount may be limited for those with a high income or those who take part in a 401K. There are two types of IRAs, Traditional and Roth.
Traditional IRA: A Traditional IRA allows you to invest money before taxes, but when you withdraw the money you will be required to pay income taxes. Any money withdrawn before age 50 ½ will be subject to a 10% penalty. At age 70 ½ you will be required to start withdrawing a minimum amount from the IRA.
Roth IRA: A Roth IRA allows you to invest money after taxes. Withdrawals are tax free, however, there will be a 10% penalty for withdrawals before age 50 ½ . If you have had the account for 5 years money may be withdrawn without a penalty if used for a down payment or education. If you are not close to retirement, a Roth IRA will give you a better tax benefit because all the earnings will be tax free.
401(k): This is the best known employee sponsored retirement plan. Employees can contribute up to 100% of their gross income up to $40,000 a year. This is a tax sheltered plan. This means that the money you contribute to the account is not taxed, but it will be when the money is withdrawn. Employees can choose from a variety of investment options that will make up their 401(k). There are different types of employee retirement plans for example; the 403(b) is a plan for non profit organizations. Make an appointment to talk with your employer to find out more about your specific options.
It is important to prepare for retirement. Social security and employer retirement plans may not be enough. Most individuals will need to invest in order to have enough money in retirement. The following chart gives an example of a current retiree and what they might expect.
Source: Personal Finance 6th Ed by E. Thomas Garmon and Raymond E. Fourge
Hint: Social Security may change in the years to come. This estimated amount of 22% may not be accurate for your planning. Stay informed of government changes to Social Security.
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Financial Fitness Fact Sheets:
Information Adapted from: Personal Finance 6th Ed and 7th Ed by E. Thomas Garmon and Raymond E. Fourge; Utah State University Family Life Center Housing and Financial Counseling Services; “ The Financial Checkup” by Alena Johnson, Utah State University Lecturer; Successful Money Management by Dr. Barbara Rowe with Kay W. Hansen and Marsha M. Peterson, Utah State University Cooperative Extension Service, November 1990; and Pioneer Investments.