Seven Tips For Saving
Learn how to save your money effectively, efficiently and build yourself a better financial future.
Define your goals when developing a savings plan because this will help determine how much to set aside each month and the type of account that best fits your needs.
"Most people save haphazardly without a strategy," says Drew Tignanelli, a principal at The Financial Consulate in Baltimore. "You want a strategy guiding your savings plan. Are you saving for short-term emergency needs – the car breaks down – or for a long-term goal such as a down payment on a house?"
The key to saving successfully: take money off the top. Set aside a pre-determined amount each month and, if possible, set up an automatic transfer from your paycheck. Otherwise, transfer the money to savings as soon as your paycheck hits your checking account.
If you plan to save whatever is left over at the end of the month, you'll quickly discover that your savings plan fails to meet your goals because expenses have a way of expanding to consume available income.
Here's what you need to do to build a nest egg:
Choose Your Account
Savings accounts come in three basic types: passbook, money market and certificate of deposit. Each has its advantages and drawbacks.
Typically, passbook accounts are for small amounts and pay the lowest interest rate. But you can make deposits or withdrawals at any time. All transactions are entered into a passbook, frequently called a bankbook, carried by the depositor and presented to the teller when conducting business. You can't write checks against this type of account and may not be able to set up direct deposit. Some banks will open a passbook account with an initial deposit as small as $10.
In most cases, a minimum deposit of $500 to $1,000 is required to open a money market account. You can tap the money at any time without penalty. Money market accounts generally pay more than passbook accounts, but less than a certificate of deposit.
Opening a certificate of deposit generally requires about the same initial deposit as a money market account, but you must agree to leave the money on deposit for a set term ranging from as little as three months to five years or more. In general, longer terms pay higher interest rates. Unlike a passbook or money market account, most CDs don't allow you to add money to your savings until maturity. A CD will pay more interest than a money market account, but there's a big catch: If you withdraw the money before the term is up, you'll probably lose all the accrued interest. So, open a CD only with money that you know you won't need in the immediate future.
Take the Long View
Think about retirement savings-If your employer matches your retirement contribution, consider it free money and contribute the maximum each month.
Give the Roth IRA a long look. It's built with after-tax dollars and, in general, makes it easier to save and withdraw your money when needed. But the advantages come at a price: contributions aren't deductible. For many savers, this is a minor point and is offset by a Roth IRA's tax-deferred growth and tax-free distributions at retirement.
The money grows tax-free and it's all yours at retirement. Who knows what the tax rate on a Traditional IRA will be in the future? If you pass Roth IRA money on to your children, it won't be taxed. In short, the Roth IRA is a too-good-to-be-true tax break – grab it, especially if you're early in your career.
A Convenient Yardstick
Use the Annual Percentage Yield (APY) to determine how much your savings will earn in a year. APY includes compounding or earning interest on your interest. Ask the bank how often your money is compounded. If it's compounded daily, you'll do better than if it's compounded quarterly. You'll do better if your earnings are compounded monthly rather than at maturity.
Some banks offer a slight increase in the interest rate paid on savings if you also maintain a checking account. Ask before opening a savings account. Don't be bashful about asking about extras, no matter how small. Banking is fiercely competitive – make the banks jump for your money.
Insuring Your Nest Egg
The Federal Deposit Insurance Corporation insures deposits up to $100,000 per depositor. If you exceed this amount, you may want to consider a Certificate of Deposit Account Registry Service – CDARS or "cedars" like the trees. In the program, your funds are split into amounts below the FDIC limit and divided among member banks to ensure FDIC coverage up to $30 million. (See: CDARS: Seeing the Forest For the Trees)
The Taxman Cometh
Interest earned on savings is taxed as income and must be declared when you file your income taxes. Each January, the bank will send you a statement of interest income earned during the preceding year. You must also supply the bank with a valid Social Security number to open a savings account.
How to Choose a Bank
Convenience may dictate opening a savings account at the same bank you use for checking, but always shop around for the best deal. A stuffy, hide-bound bank may still keep bankers' hours. If that doesn't match your needs, find a bank with extended daily and weekend hours. You'll also want a bank that has branches near your office and your home.
If you maintain a minimum balance, often checking and savings combined, you can avoid most fees. Always read the terms of your account and ask about standard and special fees because, with a little planning, you can avoid them. There's no reason to pay any bank for the privilege of having your money or carrying its credit card.
An online bank may offer a slightly better interest rate than the brick-and-mortar bank on the corner, but consider convenience, including customer service, clearing and how long it takes to get your hands on your money. An online bank may be slow to credit your savings account with a large deposit. This is annoying and costs you money in lost interest.
Online brokers such as ING (ING), Charles Schwab (SCHW) and Fidelity might be a better alternative to Brand X online banks. Many brokers offer checking and savings accounts at attractive rates.
When looking for the best deal in a savings account always read the terms and shop around. Check with friends about a bank's reputation for customer service, but don't open an account at a bank just because that's where your friends stash their cash. When opening a savings account, revel in one of the great strengths of capitalism – competition – and get the deal the best meets your needs and goals.
"People have to learn how to live off less than they're making," Tignanelli says. "That's a foreign concept to an American because we like to live off 110% of our salary."
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