Since the recent recession, regaining control of your finances and living frugally has almost become cool. Instead of spending more than we make, the average American is no saving nearly 5% of their income for a future unexpected event. This is one tremendous turnaround, and I am glad to see this shift in our habits.
While many may claim that the new mentality of ‘saving’ is hurting our economy, I think it is preventing an even greater catastrophic event in the future. If spending and borrowing continued to soar, everything would fall apart with an even sharper decline. It’s best that we lick our wounds now rather than lose our limbs in the future.
What Do I Do With My Savings?
Since this concept of saving is new for many of us, we often wonder, “Ok, I have money now, but what do I do with it? I feel like I should be investing it.” Before you get ahead of yourself, here are some questions that you should ask.
- Do you still have consumer debt? (School loans, Car loans, Credit Card balances)
- Do you have 6 months worth of expenses in savings?
- How much is your savings currently earning?
Consumer Debt
If you still have school loans, car loans, credit card loans, or any other consumer debt, this is your first priority. Most of these debts probably average more than a 7% interest rate, and chances are that your investment has a pretty small probability of earning that amount.
Let’s say that your odds of earning 7% on your investments are 10%. That means that you have a 10% chance of earning more than 7% interest on your money. But, you know what’s going to pay you 7%, 100% of the time? Yep, those consumer debts. Don’t try to be a hero and beat the market, just earn back your 7% by paying down those consumer debts as soon as possible. Plus, let’s just face it; if you have credit card debt, you’re probably paying far more than 7% in interest! Pay down those debts first!
Saving for an emergency seems pointless… that is, until there’s an emergency. And, let me tell you, there always is! At some point in your life, you will have a financial emergency. The roof will need replacing, the water heater will explode, and you may even need to rid your house of termites someday. Emergencies have a way of finding everyone.
Since no one knows when that emergency will strike, we must save for it now. Financial Planners used to say that you should have 3-6 months worth of expenses in savings, but since we live in times of uncertainty, I say that you should have at least 6 months worth of expenses in a regular savings account.
If you currently do not have any emergency savings, then you most certainly should not be putting money toward your investments! Some of you may argue, “But I can always take it out if I need it!” This is true, but it takes time and you’ll most likely be penalized for your withdrawal, especially if your investment is in a retirement account. Others of you may think you are wise by stating that “I can borrow against my investment tax-free as long as I pay it back.” This is a very slippery slope as well. What if you get let go from your job or you’d like to accept a new one? The borrowed money will most likely be owed back into your account immediately. If it’s not, let the penalties begin! You don’t want to find yourself in this situation.
Your Savings Account
If your bank account earns more than 5% (I have a checking account that currently yields 4%), you may want to leave your money where it is. CDs, bonds, and T-bills don’t even earn that much, and the market is so volatile at this point, there’s no telling what it could do next.
You’re Ready to Invest
If you have paid off your debts and have saved a fully-funded emergency account, you are now ready to invest. I know it’s tough to wait, but just think of how quickly you can grow your money now. You have no debt payments and have cash on hand in the event something should go wrong. Wealth will be knocking at your door in no-time!
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That is a great point about paying down debt before investing. Although for those between the ages of 18 to about 28 I would say split saving for emergencies and paying off debt with investing. Time is our most valuable asset and it cannot be replaced.
Everyone should definitely have an emergency fund in place before they start paying off debt, but only about $1,000. Once the debt is paid off (this should be done as quickly as possible by the way), then you should beef up your emergency fund to at least $10,000.
Thanks for the comment FSYA!
you have a checkings account that earns 4%??!?!? that is unheard of in this day in age. i’m curious. where?
Saving and investing are inmprtant, no matter the other circumstances. It may seem better mathmatically to pay off debt instead of investing. But, most people will ring the debt back up and have zero savings.
For me it’s:
1. Savings
2. Debt
3. Bills
4. Living
Bret
“most people will ring the debt back up and have zero savings”
I’m sorry to admit it, but I think you’re right about many people. Why don’t we learn from our own hardships? The media continues to convince us that we need more and would be happier with stuff, even if we don’t have the funds to pay for it right now.
Hopefully we’ll learn someday…. once we get out of debt, we’ll stay out of debt.
Derek,
I think a lot of people are finally starting to get it. They are turning their back on consumerism and questioning the value of buying so much stuff. The savings rate is back up to 5% from a low of -1%. I just hope it lasts longer than a couple of years. And, I hope a lot more people start to catch on.
I think you just inspired this week’s post.
Bret
Thank goodness huh? People are finally starting to get it. I like that fact that savings are up. However, like you said before, these things tend to be cyclical. When times are good and investments are soaring, people will once again overspend and under-save.
I’m glad I could inspire your next post!
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