Saving money is hard. It requires self-control in the face of continuous bombardment by scientifically engineered marketing messages, peer-pressure and brains “designed” for immediate gratification. For many of us, it requires investing some quality time to mindfully design a sustainable budget that’s in line with our values. (We think we’ve figured out how to make this easier, with our Happy Budget®!) It’s also risky: we know how much we’d enjoy spending that $100 now. Maybe the investment we put it in craters. Even if does become $400 later, do we even care about that future self who gets to spend it?
The least your savings can do for you is work as hard as you do.
The least your savings can do for you is work as hard as you do. A dollar under the mattress is clearly not the same thing as a dollar in a carefully built investment portfolio or used to repay high-cost debt. So how can we make our money make more money for us?
The place to start is your Net Worth. Net Worth measures the difference between our assets (cash, investments) and our liabilities (credit cards, mortgage, and other debt). Assets only tells half the story because you eventually have to repay liabilities from those assets and future income. Focusing on Net Worth helps us to think holistically and find the best use for our savings.
How can we build Net Worth as fast as possible?
- Save as much as possible. This can matter more than how you invest. Saving an additional one percent of income can be more important—and certainly more reliable—than trying to earn an additional one percent on your savings. One simple strategy: instruct your employer to direct deposit your income into a savings account and direct your bank to automatically transfer a smaller amount to checking each month as your “allowance”, to help you save without a lot of work. The chart below shows how each $100 one saves each month could translate into an $411 of greater monthly retirement income, thanks to the magic of compounding.
- Understand that repaying debt can be better than investing. When you make more than the minimum payment on credit cards and other debt, it’s like making an investment whose return equals the interest rate on the debt (APR). For example, repaying a credit card with a 20% interest rate is like earning 20% tax-free on the investment. This is because your reduced interest charges are just as spendable (and saveable) as investment income. In some cases, paying down your debt can be better than contributing to a 401(k), even if the employer matches your contributions.
- Consider the tax effects. Traditional IRAs and 401(k)s investments allow you to cut your tax bill today because the contributions may reduce your taxable income. You can, in theory, invest that tax savings. You’ll have to pay taxes on withdrawals at the ordinary income tax rate when your retire, which will hopefully be lower than your current tax rate. Roth IRAs work the other way: no tax break today, but you can withdraw tax-free in retirement.
- Prioritize an Emergency/Opportunity (E/O) fund. This is money you set aside to manage the ups and downs of income and unexpected expenses, without going into debt. We’ve all experienced surprise medical or repair bills and periods of unemployment. On the other hand, we sometimes come across opportunities to invest or spend when we find a good deal. How big should this E/O fund be? A good starting point is to take the number of months it might take you to find a new job, and multiply by your typical monthly expenses. You might keep your E/O fund in a separate savings account that is not too convenient (to keep help keep the commitment) but still earns some interest. (A more sophisticated strategy would have you consider unused credit card capacity as part of your E/O fund.)
The sample chart below shows one way to rank savings options, and was created by the Decision Fish Financial Wellness app.
We save because it’s the right thing to do, because it makes us resilient in case of unexpected expenses, or because, when we have enough, it gives us the freedom to do the things we want to do. If you are actively saving enough, and have accumulated the right amount for you, then you’ve probably achieved Financial Wellness:
Financial Wellness: a state wherein a person can fully meet current and ongoing financial obligations, can feel secure in their financial future, and is able to make choices that allow them to enjoy life. — Consumer Financial Protection Bureau
In sum, you work hard for your money. It should work hard for you. You’ll get to financial wellness faster by focusing on your Net Worth, building an Emergency/Opportunity fund and tacking high-cost debt first.
Note: We do not provide investment, tax, accounting or other advice or recommendations.
This is the last of a three-part series of financial wellness articles that describe the philosophy behind the Decision Fish App and Workshops. To Catch Up, read: Seven Good Reasons NOT to Save, then Beat the Budgeting Blues.
Decision Fish is building a fun, online financial wellness program. We are looking for people willing to try it out early, even before it’s available to the public. Do you want some informal financial coaching yourself or work at a company that still doesn’t offer a financial wellness benefit? Let us know!