The time to set a habit of frugality – of saving – is as early as possible, ideally when you’re in your early to mid-20s. Because of how compound interest works, every dollar you save early in your career is worth more than a dollar saved later in your career. The trick to saving in your twenties is to make the savings process as automatic as possible.
If your employer offers a 401(k) program, contribute to it, and have the money taken out of your paycheck. Most 401(k) programs have an employer matching level – typically 4-9% of your salary. What this means is that for every dollar you contribute to the 401(k) up to this threshold, your employer will match it – effectively doubling the investment up to this amount.
The second benefit of a 401(k) is that it comes out of pre-tax income; in most states and professions, this effectively means that every dollar you contribute to a 401(k) only takes 85 to 77 cents out of your paycheck.
The third benefit of a 401(k) is that any interest it accrues is tax-deffered. It doesn’t count as income until you withdraw from the account, and you can withdraw from it at the same time you’re eligible for Social Security Retirement benefits.
The final benefit of a 401(k) is something of a mixed blessing: 401(k) are par t of an investment portfolio – which means they’re at the vagaries of the stock market. It does mean that if you can contribute to a 401(k) when the market is down considerably (as it was in 2008-2009), you’ll see some substantial returns.
By and large, if you can, set your 401(k) as a “set it and forget it.” The longer you let it run without touching it, the happier you’ll be with the end result.
General Savings Plans
Once you’ve got your 401(k), you should figure out your monthly income and try to set your monthly expenses at 90% of that amount – and put the remaining 10% in the bank. One technique that works very well, if your employer offers Direct Deposit, is to split your deposit so that roughly 10% of your expected income is deposited into a savings account and the remaining 90% into your checking account, and try to forget that the savings account is there for a while.
When your savings account has a balance sufficient to support you for three to four months with no income, draw two months worth of income out of it and buy certificates of deposit, or CDs. A CD is like a savings account with a time-lock on it. In return for this time-lock, banks pay higher interest rates on CDs. You can buy CDs with staggered maturation rates; for example, buy your first CDs to mature in 3, 4, 5, and 6 month durations. Each time you have enough money to buy another CD, buy one that will mature one month later than your latest maturing CD. Whenever a CD matures, re-invest it the same way. Eventually, you’ll end up with a pipeline of 36 or 48 CDs, with one maturing every month, and periodically feeding more into it This gives you a greater rates of return than your savings account while still maintaining some fluidity.