A good number of my columns tend to focus on various investment topics. One area that I have not covered as much, is saving money. It is quite obvious that if someone doesn’t have any savings, there is nothing to invest.
People save for various reasons. The savings might be for a down payment on a house, a college education, an emergency fund, and of course for retirement.
There are others who save a certain percentage of their pay each month, but may not have any specific goal in mind. The problem with not having savings earmarked for anything specific is not knowing how the money is to be invested.
Someone who saves just for the sake of savings will likely be putting their money in a savings or money market account. This process oftentimes will go on for many years. However, as we have seen from recent years, savings and money market accounts pay virtually nothing in terms of interest.
This is why it is important, when a person saves that he/she has some specific goal in mind. If the savings is for something fairly short term in nature, like a down payment on a house, then the money should be invested conservatively. However, savings that will likely not be needed for many years can be invested in riskier assets, such as stocks.
Longer term savings, which would tend to be oriented more towards retirement, can be invested in retirement accounts, or in a personal account. Retirement accounts, such as a 401K plan or an IRA offer specific tax advantages that a personal account doesn’t have.
Therefore, when saving for retirement, it would be best to take advantage of the 401K plan at work first, especially if there is an employer match, since that is essentially free money. Only if someone knows that he/she will not be with that specific employer long enough for the vesting period, would it not make sense to be part of that plan.
If someone has savings left over after contributing to a 401K plan, then investing in an IRA would be the next account to have for retirement savings. For higher income people there would be some income limitations in terms of using an IRA. Only after having the 401K plan, an IRA if eligible, should someone then use personal money to supplement retirement savings.
It should be noted that for many people having adequate savings is not easy. Studies have shown that most people in their 50’s who are approaching retirement do not have adequate amounts in retirement savings, or from likely pensions and/or Social Security benefits to be able to support their current lifestyle.
Living in our local area, the high cost of housing certainly makes savings more difficult versus other parts of the country. This is especially the case, because wages here are only modestly higher than the national average, while housing expenses are much greater.
It is not my intent to specifically recommend what someone should spend their money on, as certain people may have stronger preferences for one type of spending versus something else. What is important is that someone have a specific plan or budget that is realistic, and that he/she stick to it, so that individual has adequate savings.
The worst thing is for someone to be stuck with high cost debt that causes a substantial portion of one’s budget to be devoted to interest payments. It would be much better for someone to be funding a retirement account rather than paying high cost interest to a credit card company.
Having adequate money for retirement involves both savings and investing. To be able to invest one must save. No matter how good an investor someone might be, if he/she is saving little, superior investment returns will likely not make up the difference.
For example someone who saves at half the rate of another person would need average investment returns approximately 4% greater per year than the more diligent saver to come out even after 30 years. This would be highly unlikely to occur. Therefore, for someone to be a successful investor that person must also be a good saver.