The words saving and investing are often used interchangeably. While there are similarities between the two — both involve costs and benefits and both are ways to grow wealthThe total accumulated value of the assets a person possesses. Financial assets include savings, stocks, and bonds. Physical assets can include real estate, rental property, gold, antiques, and other collectibles. and help reach future financial goals —it is important to understand their differences.
Saving involves putting aside a part of one’s income and not spending it on goods and services. A passbook savings account at a bank and a certificate of depositA CD is a form of time deposit at a bank or other savings institution. A time deposit cannot be withdrawn before a specified maturity date without being subject to an interest penalty for early withdrawal. Small-denomination CDs are often purchased by individuals. Large CDs of $100,000 or more are often in negotiable form, meaning they can be sold or transferred among holders until maturity. (CD) are examples of savings activities. They are both products insured by the Federal Deposit Insurance CorporationAn independent agency of the federal government that insures accounts up to $250,000 per depositor at almost all United States depository institutions. This deposit limit was increased from $100,000 by the FDIC in October, 2008, in response to the banking system crisis. The insured amount of $250,000 is effective through December 2009. The FDIC has primary federal supervisory authority over insured institutions that are not members of the Federal Reserve System. (FDIC).
Savings grow money because of interestAn amount of money paid for using funds over a period of time, generally an annual percentage rate. Bank interest is both an amount paid to depositors of funds and a finance charge for money that is borrowed. The price that someone pays for the temporary use of someone else’s funds. Interest is also a compensation that someone receives for temporarily giving up the ability to spend money. and the compounding of interest. Savings also provide funds for investmentProperty or other possession acquired for future financial return or benefit; also a commitment of time (e.g., to education or training). s to build future wealth.
First Steps to Saving
Track Your Expenses
Keep a “walking around” spending log for one week. Identify how much of your spending was for wants —
Walking around money is money a person uses for routine expenses. By reducing the amount of money that you spend on non-essentials and purchasing only the things you need instead of the things you want, you can turn some of your walking around money into savings and investments that can greatly influence your future wealth.
Track how much you spend on a typical workday then calculate what you spend over a week, a month, and a year for the your current routine. For example, if you spend $20 a day in walking around money, you will be spending $100 a week, $400 per month, and approximately $4,800 per year. If you cut your spending to $15 a day and put the other $5 ($100 /month) into a savings accountAn account at a financial institution that earns interest and allows regular deposits and withdrawals. The minimum required deposit, fees charged, and interest rate paid vary among providers. earning 5% compound interestInterest that is calculated not only on the initial principal but also the accumulated interest of prior periods. — interest calculated on both the initial principal and any accumulated interest — by the end of 5 years, you would have $6,937 in your account. By the end of 20 years, you would have $41,011!
Enter your starting balance and monthly deposits to calculate how much you could save over time.
If you open a savings account with $ earning % interest and
deposit $ a month, you would have $ in savings in .
Use the controller below to graph your savings potential.
Remember you have only been looking at the daily spending of $20 for walking around money. There could also be other ways to save money out of present spending on variable expenses.
After cutting and prioritizing expenses, there is one key step before deciding how to grow your savings and investments. This is your emergency fundMoney set aside or budgeted for unanticipated but necessary expenditures. . When properly managing your money, you will make sure to have a separate pot of money set aside from your checking account specifically for unexpected emergencies, separate from savings for a specific goal. This is an often overlooked concept.
The bottom line is you should have at least enough money to cover 3 months of the expenses you listed in your budget. Most emergency funds represent enough money to cover 6-9 months’ worth of expenses. You can build it up to be more than that if possible.
If you or a family member loses your job or experiences a reduction in income, an emergency fund can help you get by. Your emergency fund is not for luxury items or vacations. If you have unexpected medical emergencies or damage your car in an accident, an emergency fund (and proper insurance!) will help you to meet those unplanned for high costs. Once you have set up this important fund, you will then be able to responsibly save and invest additional money with some peace of mind.
Money for Tomorrow
Almost universal saving and investing advice is to save regularly and begin to save today. By understanding the compounding of interest, you can calculate how saving helps you reach your goals (e.g., buying a house, starting a small business, building a mountain cabin, or pursuing a higher degree).
Investing occurs when people use money they have saved to buy, for example, real estate, stockThe capital raised by a corporation by issuing shares of ownership; a certificate documenting a proportional share in the corporation’s assets and profits. (Also known as an equity.) , or corporate bonds. You can invest in a mutual fundFunds from many investors pooled together to establish a diversified portfolio of investments. Mutual funds raise money by selling shares of the fund to the public. Shareholders are free to sell their shares at any time. Many employees invest in mutual funds through their employers, by setting aside some of their wages to invest in one or more funds on a regular basis. or a financial venture. Investing can also include using saved money to purchase foreign currencies, metals, gems, or art or to start one’s own small business. There are many investment options, but the road to investments almost always begins with savings.
Investing involves risks not experienced by people who save only through insured accounts or certificates of deposit (CDs). However, investors generally expect to gain bigger financial rewards in proportion to the risks involved. Investments are sometimes categorized as having little or no risk or carrying a very high risk. Each person’s tolerance for risk and objectives for investing are different.
Identify Your Long–term Goal
Identify your own long-term goals. Saving and spending decisions now will affect your ability to achieve these long-term goals. An understanding of basic financial concepts about budgeting, saving, and growing money through investments can provide a foundation for reaching goals over your life time.
For many people, the purchase of their first home will be the largest single investment they will make in their life time. You will need to save for a down payment, be able to compare the costs and benefits of home ownership and qualify for a loan.
Suggested websites for research can be found in the Resources section. Note that there are numerous mortgage calculators on the Internet that can assist you to quickly make comparisons among the costs of various mortgages. These comparisons provide dramatic evidence of the importance of “shopping” for a mortgage.
When deciding to purchase a home it is important to consider many factors. For example, in deciding to buy instead of rent you will now be responsible for all of the repairs and routine maintenance on the home. It is essential to factor these costs into your new budget. When calculating what home is affordable, remember to consider the cost of property taxes and homeowners insurance. What you pay monthly in principle, interest, taxes and insurance should not exceed 30% of your household budget. Be careful not to budget so tightly that one unexpected event (a flood in the basement, temporary job loss, or loss of rental income) could throw you into foreclosure.
It is important to consider the many types of loan products available. Use an internet calculator to determine the difference in savings on a 15, 20 or 30 year mortgage for the same size loan. Typically the shorter the term of the loan, the lower the interest rate. Also consider a bi-weekly mortgage payment plan, which can considerably lower costs.
The interest rate for which you qualify will be affected by factors such as the current market rate, the length of the loan, the percentage of the down payment, and your credit score. (For ways to improve your credit score, see the Credit and Debt section). Be aware that if you are not prepared to make a 20% down payment, you can end up paying more over the life of the loan, in both PMI (private mortgage insurance) and higher interest.
If you are in danger of losing your home to foreclosure, or fear you will not be able to make your mortgage payments in the near future, contact a non-profit housing counselor or legal services agency. There are many for-profit companies offering mortgage modification services that are available free of charge from a non-profit agency. See the Resources section on how to find a counselor in your area.