Why is it important to save?
We all have hopes and dreams. For some that may include traveling through Europe or pursuing a higher education; for others it might be saving for a home, a car, or our children's education. The money for these things is not going to magically appear, so in order to make your dreams a reality you have to develop a savings plan and contribute to that plan on a regular basis.
Putting your money into a savings, investment or retirement fund enables you to let your money grow for you. This is largely due to the miracle of compound interest, which has been described by some as the eighth wonder of the world. With compound interest, your initial investment earns interest, and your interest earns interest. The effect is like Miracle-Gro for your money. At first, your money grows slowly, but then increasingly large amounts are added to your investment over time.
Let's take a look at how a one-time investment of $1000 can grow over time. Let's assume an average interest rate of 5%.
So, a $1,000 investment grows to more than three times that amount in 25 years. And that's assuming that you never contributed additional money after your initial investment. Now, imagine if you did add to that investment each month. Starting with an initial investment of $1,000, if you were to add $100 a month for 25 years, with an average interest rate of 5%, your investment would grow to $63,032. Your actual deposits were only $30,000, but the total interest earned was $33,032.
Saving for an emergency
The one sure thing about life is that it is unpredictable. The curve ball that comes your way may be a fender bender or a leaky roof. Or it might be something more serious such as an illness, death or loss of a job. Regardless of the nature of the event, if you have not set aside money on a regular basis, you can easily find yourself in serious financial trouble. For that reason, some experts suggest that you have savings equivalent to 6 months of your annual income.
Getting started with a savings plan
Writing down your goals is the first step. Next, you'll need to figure out what you can afford to save each month. To do that, create a budget and see how much money is left over from your net income after all your expenses are paid. Sometimes it will be necessary to cut back on certain items or find ways to supplement your income in order to reach your goals.
Hopefully, you'll be able to save at least 5% of your salary. But even if the most you can save is $50 a month, commit to putting that amount into your savings or investment account every month. You might even ask your bank to set up an automatic funds transfer each month to help you consistently make those deposits.
Should you save or pay off debt?
If you are carrying a lot of high-interest debt, you should evaluate whether the interest that is accruing on your debt will exceed the interest that you could be earning on savings. If so, you might want to consider paying off the debt first.
Where should you put your money?
There are different savings and investing products. Lower-risk products, such as savings accounts or CDs (Certificates of Deposit) are the safest places to put your money, but they will not earn as much interest as higher-risk alternatives such as mutual funds, stocks or bonds.
When deciding where to put your money you'll want to consider how much time the money will have to earn interest or returns, your risk-tolerance, and what kind of accessibility to the money is required. For short-term financial goals, consider a savings or money market account, which will earn interest but not penalize you if you need to withdraw money in the short-term. Certificates of Deposit or short-term bond mutual funds may be good options for money that you won't need to touch for about five years. If you're working on your "nest egg", you may want to consider investing in mutual funds, stocks, an IRA or a retirement plan available through your employer, such as a 401(k) plan.
Savings & Investing Links:
Calculate how much you will save over time: CNN Money's Savings Calculator