The 10% Savings Rule
Sometimes I think the simplest solution is often the best. This is a perfect example of this. In cutting to the point early on, you should always put 10% of the money you bring home into a savings account. But before we focus on whether to save in a CD, IRA’s etc., let’s focus on one thing first. Just save the money.
Often we find ourselves with such a tough budget we often don’t know where to start. I imagine when a mountain climber looks at some the tallest mountains in the world there is the thought in the back of their minds that it is insurmountable. And, approaching it from that angle – it is. One cannot take one big step and be at the top. It is a process of taking one step at a time and slowly making your way towards to the top. The good news is, given enough time and steps, they do make it to the top.
Building wealth for yourself is no different. Each step, no matter how small and seemingly insignificant, takes you closer to your goal. The harder it is to put away 10%, the more important it is for you to do it. Say 10% for you is $100 per month. After a year that is $1200, which, if that is all you could afford to put away, should be a pretty good sum for you.
There is another benefit. Your mindset begins to shift. When you have money, whether you spend it or not is irrelevant – you could. “Having” the money alone makes one feel wealthier and once you start down that road… you won’t look back. There is a feeling of security that goes with that. In the end, that may be what you are looking for – not only the money itself, but not worrying about money.
Now that we’ve covered why you need to saving money, let’s focus on the variety of methods available to you for making your savings count (as defined by the glossary on www.motleyfool.com).
- CD’s: Certificate of deposits (CD’s) are an insured, interest-bearing deposit at a bank, requiring the depositor to keep the money invested for a specific length of time.
- IRA’s: A tax-deferred retirement account set up with a financial institution such as a bank, broker, or mutual fund in which contributions may be invested in many types of securities such as stocks, bonds, money market funds, CDs, etc. The Individual Retirement Account (IRA) brings together two tremendously powerful forces, both of which benefit you: compound interest and tax savings. IRA’s are tremendous long-term investments where compound interest becomes even more powerful when it is not held back by the drag coefficient of taxes.
- Savings Accounts: A bank account that usually offers low-yield, but highly protected interest rates. The safety and ease of acquiring such accounts has led to their immense popularity.
- Money Market: A mutual fund invests in very short-term, high-liquidity investments. Similar to a savings account, though usually offering better interest rates.
- Municipal Bonds: A debt instrument issued by a state or local government. The advantage of investing in municipal bonds (or “munis”) is their exemption from federal, and sometimes state and local, taxes.
- Mutual Funds: The pooled cash of many shareholders that is invested according to a stated objective, as defined by the fund’s prospectus.
- 401(k)s, 403(b)s, and 457s: Employer-sponsored retirement plans named after the respective Internal Revenue Code sections in which they appear. Given their tax advantages and the possibility of employer matching, these plans are well worth considering. For-profit entities offer the 401(k) plan, nonprofits have the almost identical 403(b) plan, and local and state governments offer the 457 plan.
- Annuities: A contract between an insurance company and a person that provides for periodic payments to the individual or designated beneficiary in return for an investment. Typically, an annuity agrees to provide payments to the purchaser of the contract (annuitant) beginning at some point in the future. Annuities are typically very poor investments, and seasoned investors generally avoid purchasing them. Insurance companies typically push selling them very hard since they usually have high fees.
Almost all savings do carry some risk, so it is up to you to determine what type of savings best matches your desired outcome. Just remember that the overriding principle here is that you simply must save 10% – regardless of the method you choose.