The time has come to accept the inevitable: You’re growing up. Embrace it! Becoming an adult can be daunting, but not when you have guides as easy (and, let’s face it, as cool) as the ones in our new Adultify series. Now, you won’t ever have to utter that cringe-worthy term “adulting” when you accomplish something, like doing your laundry—you know, basic, responsible grown-up activities—because you’ll know these truths to be self-evident.
It is a truth universally acknowledged that an adult in possession of a good fortune must be in want of a savings account. Butchered Jane Austen prose aside, it is an unavoidable part of responsible adult life to take care of your finances. And that doesn’t just mean making sure you’re paying off your credit cards on time and not overdrafting—although it also means that.
The reality is that you need some cash squirreled away not only for your retirement (which is probably in the far-off future), but also in case something goes wrong (a medical emergency, loss of job or home) in your life.
“You need a doomsday fund, a treasure chest, an ‘oh, crap’ fund, a ‘break in case of emergency’ fund. Not to mention a ‘because I want to live fabulously in retirement’ fund! Whatever you want to call it, you need one before you do anything else with your money,” says Nicole Lapin, financial expert and New York Times best-selling author of Rich Bitch. “That wad of cash under your mattress isn’t going to do you any favors.” Instead, she suggests tucking a little bit of your paycheck away each month.
“While the purpose of your checking account is generally to cover monthly bills and daily transactions, your savings account is designed to help you preserve and ideally grow your balance over time,” says Brandie Farnam, LearnVest's manager of advice excellence. “That potential for growth comes from any interest you earn on the balance, as well as any additional contributions you make to your savings account.” But even with the best frugally motivated intentions in mind, sometimes stashing anything away seems hard, thanks to the ultra-low entry-level paychecks which exist in pretty much every industry. Add in the fact that most of us have student loans and general high costs of living with which to deal, and a savings account seems damn-near impossible. With that in mind, we consulted Lapin and Farnam to get their tips on how to put away money even while living that paycheck-to-paycheck lifestyle.
To begin, there's one thing they both can’t emphasize enough: You should start saving as early as you possibly can. “Don’t wait! Having a safety net is essential to your financial health and will help you build a solid foundation,” says Farnam. “That way, you build good money habits and can gradually increase your contributions over time.” In other words,whether you’re saving for the iPhone 7 or a long-term goal like a vacation or retirement, it’s time to get to the bank and open a savings account. Read on for our 101 on savings.
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Pick the best savings account out there Before you open a savings account at the bank where your checking account currently lies, shop around. “You want to pick a savings account with the highest yield possible, meaning that you get back the most interest on whatever money you’re putting into the account,” says Lapin. When opening up a savings account, inquire about the interest rate, which, in the simplest of terms, is what you pay when you borrow money (for example, a student loan) and what you receive when you lend (for example, when you are leaving money untouched in the savings account, enabling banks to use it as loans). “Essentially, an interest rate is a return on your money or a premium paid to borrow funds,” says Farnam. “While interest rates on savings accounts are generally not considered high, they are typically higher than what you’d get in your checking account because the funds are intended to be stored at the bank.”
Farnam suggests comparing interest rates, account minimums, and features like sub-accounts of providers and opening a no-cost, high-yield online savings account to earn the most interest on your cash. When it comes to interest rates, Lapin says to keep in mind compound interest. “A compound interest is the money you make off the interest on the money you are saving. That means it’s really ‘interest on interest; which will make an investment grow at a much faster rate than regular ol’ interest.” Lapin uses this example to further explain the concept: A 20-year-old woman who puts a one-time $5,000 investment into a retirement account will have $160,000 by the time she retires. However, if she had waited until she was 40 years old to invest the same amount, she would have only $40,000 by the time she retires. Let’s say, however, that this woman puts in $5,000 per year starting at age 20. By the time she retires, she will have… almost $2 million.
Assess your money flow First, let’s dispel the myth: It is possible to put away money for savings while living paycheck to paycheck. It simply requires more monetary organization, aka budgeting, than you currently maybe be used to and an “every bit matters” mentality. “Before you even think about budgeting, you need to get an accurate snapshot of what your finances look like. I mean, really look. No more hiding!” says Lapin. Understanding exactly where your money goes every month and establishing reasonable monetary expectations are key in maintaining a balanced budget.
To get a sense of your expenses and how much you have left over to save after all is done, Lapin suggests setting a table with two columns, putting everything you have (assets) on the left and everything you owe (liabilities) on the right. Subtracting your liabilities from your assets will give you your net worth. “You can’t even begin to budget until you know what you have coming in and going out each month,” she says.
Farnam similarly advises assessing your finances critically. She suggests adding up all the “fixed” expenses (housing, utilities, cell phone, etc.) and minimum debt payments (student loans), and dividing that total by the monthly take-home pay (the amount that hits your bank account after taxes) to get a percentage of your income. “Ideally, no more than 50 percent of your take-home pay should be allocated to fixed expenses, 30 percent or less to day-to-day expenses, and 20 percent or more to your goal contributions,” Farnam says. “If you’re close to the 50 percent target, you should be able to free up dollars to help you start saving, simply by creating a flexible framework for your budget that you can stick to.”
If the above 50/30/20 benchmark doesn’t seem doable for your budget, don’t give up. You can still learn to set a realistic budget by clicking to the next slide.
Now, set a budget To create a customized budget, consider this framework: Begin by adding all your monthly expenses—like rent, utilities, transportation, and minimum debt payments—and subtract from your home pay. Don’t forget to account for all the non-monthly expenses that will come up throughout the year, like gifts, insurance, and holiday travel. “These tend to be a blind spot for a lot of people,” says Farnam. She suggests adding the amount you spend on any non-monthly expenses over the course of the year and dividing by 12. “That way, you can build these into your new budget so you have the cash ready when these expenses pop up.”
The next step is to subtract your goal contributions. These include any payments beyond the minimums on your student loans, credit cards or other loans, as well as any savings contributions. The amount left over should cover the non-fixed everyday costs that tend to vary each month (groceries, shopping, eating out, happy hours, and the like). “This is the amount that you can spend however you’d like each month, knowing that as long as you’re sticking to it, you’re not in danger of going over budget,” says Farnam. “Divide that amount by 4.3, and you’ve given yourself one weekly number to go by.”
When it comes to the perfect digit that you should be saving, Farnam says that one should work toward the 20 percent target for goal contributions. If that’s not plausible, “start with a goal that seems challenging, but doable for you. It may be 1 percent if you need to get into a good rhythm with your budget first or 10 percent if you’re ready to make some big changes,” she says. “The important thing is that the target you set for yourself is sustainable so that you’re motivated to build on that momentum!”
Lapin suggests a slightly different breakdown with 15 percent of the monthly paycheck dedicated to savings, or what she refers to as the “Endgame:”
Think about dividing your budget into the Three E’s: Essentials—70 percent of your overall monthly budget for basic expenses like rent or mortgage, utilities, food, transportation, insurances; Endgame—15 percent of your monthly budget for things for your future like savings accounts, investment accounts, retirement accounts; and Extras—15 percent of your monthly budget for, well, whatever does it for you.
Similar to Farnam, Lapin considers 15 percent to be the ideal number in a perfect scenario, one that she acknowledges might not entirely fit with every entry-level budget. “It sounds cheesy, but every little bit counts,” she says. “Start small, say around 5 percent of your monthly paycheck. Get comfortable with that amount, nailing it for a few months in a row, and then ramp it up to 7 percent. As you adjust your lifestyle to hitting each new percentage, you’ll find you really can commit more to savings.” She points out that even if you save just $100 per month, that will put you at $1,200 at the end of the year, which is enough to cover a minor medical emergency or unexpected car maintenance.
Use helpful apps If mapping a budget and doing all the math seems daunting to you, try financial apps like Mint and Digit that track your spending patterns and pull out the savings for you. “I also recommend any bank that has an automatic savings plan, in which you can elect to deposit a set amount of your paycheck directly into your savings account each month,” says Lapin. “You’ll be less tempted to spend that money if you never even see it in your checking account.”
Pay off your student loans We get it: On one hand, you have student debt that needs to be repaid in other to avoid the interest rate skyrocketing over the years. On the other hand, you need savings should something unexpected come up on a rainy day. “In the event of an emergency or job loss, you don’t want to dip into even more debt to cover it,” says Lapin. “So, as difficult it sounds—and it’s actually not—you should pay down debt and build savings at the same time.” Farnam agrees that your percent target for goal contributions should include student loan payments beyond the minimums and savings contributions.
So quit making student loan excuses as a way to not save, and follow this Lapin-approved formula:
Make the minimum payment plus 5 to 10 percent, which will put you slightly ahead for next month, and then also stash away 5 to 10 percent of your monthly paycheck into savings. As you grow more comfortable with this strategy—and hopefully make more money—ramp up the percentage put toward both.
If student loan payments are seriously straining your budget, Farnam suggests contacting your lender to see if you are eligible for an income-based repayment plan. “An income-based plan may have more manageable monthly payments, but could increase the amount of interest paid over the life of the loan,” she says.
Watch your spending If you find that more than 70 percent of your income is dedicated to fixed expenses and monthly minimum debt payments, it’s time to review your fixed expenses to see what you can PERK: postpone, eliminate, reduce, or keep. “Living paycheck to paycheck can seem like a never-ending cycle, but it is possible to overcome it. To create some breathing room in your budget, consider reducing expenses, increasing income or some combination of both,” says Farnam. “As you go through this process, keep in mind that you can either make adjustments by moving one pebble at a time, meaning a bunch of small cuts, or moving a boulder, meaning cut one large expense.” In other words, look at your spending honestly, and see if there is anywhere where you can trim your spending.
“I’m all about cutting back on the mindless expenses you pay every month without even thinking about it. And that means negotiating everything,” says Lapin. She suggests calling your main service providers (cable, cell phone, credit cards) at least twice per year to negotiate a better rate, and to always get an itemized receipt for any medical bills. Make sure you are using the services you’re paying for (which might mean saying goodbye to bundle programs) and threaten to leave for a competitor. “Most providers will throw you a bone versus losing you as a customer,” she adds. “Take any money you save via negotiating and dump it right into your savings account. After all, it’s your money. Fight for it!”
Likewise look at your food consumption costs. You can easily spend $10 a day by eating out. Shop at a grocery store and purchase everything you will need for the week ahead. Prepare all of your lunch meals on Sunday night and store them in containers for the week ahead to bring to work. Similarly, limit the number of nights a week that you eat out or get takeout which can add a significant dent to your budget.
In addition to saving, see if there are ways that you can make additional income. “I’m all about saving, of course, but what’s often overlooked by other financial experts is the power of making more money. After all, the more you make, the less you have to save,” says Lapin. If you have any clothes that are in good condition, that are just sitting in your closet, look into selling them on a website or at a consignment store. Do you have a knack for craft making? Consider selling your pieces on Etsy. Are you a decent writer? Try your hand at paid online reviews or freelance writing. Into sports? Ref high school games on weekends. “These are great ways to indulge your passion projects while making a little extra coin on the side.” Just calculate how much you would pay in taxes for gigs like that to make sure it’s worth it.
Have an emergency fund With more millennials struggling to find jobs and the job security equilibrium still being balanced out following the recession, a stashed pot of cash is a must. “Having an emergency fund not only helps you weather any storm, but it also provides flexibility and freedom when it comes to making big life decisions like pursuing a career change or cross-country move,” says Farnam. She suggests starting small, focusing on building a one-month safety net to avoid having to rely on a credit card in the event of an emergency or major unexpected expenses. Ultimately, the goal is to work toward saving six to nine months of income to protect yourself against the unexpected (say, a job loss). “This is especially true if you have less secure employment or less steady pay, à la bartenders, waitresses, and freelancers,” adds Lapin. “And if you work mostly on commission, like real estate brokers or salespeople, you’re probably going to need more reserves—a year is probably a better number for you. Calculate what that number is for you, then divide by 12. This is the amount you should target tucking away each month to get to your baseline goal.”
Farnam suggests keeping your emergency fund at a different bank than your checking account, so there’s less temptation to dip into your savings. “Besides your emergency savings, decide what other goals you may want to start saving toward. A car? A trip? A wedding? Starting a family? Then, set up separate savings accounts for each of your goals to make it easier to track your progress,” says Farnam.
Look into your 401(k) A 401(k) is an employer-sponsored plan that may be available to you through your work. “Contributions are typically withheld straight from your paycheck, which can help make saving a priority and reduce the temptation to spend the funds,” says Farnam. The contributions may be pre-tax, which reduce your taxable income, or post-tax, in the case of a Roth option. “The benefit of the Roth is that it enables you to take tax-free withdrawals on your contributions and earnings at retirement, which could be substantial tax savings.”
If your employment offers a 401(k), it’s important to note whether they match your contributions. If that’s the case, aim to contribute the least amount needed so that your employer matches it and you get double the contributions, thus getting the most bang for your (and your employer’s) buck. “Know that you don’t have to participate just because a 401(k) is offered to you. If your employer doesn’t match contributions, or if there are high fees involved, or if the plan doesn’t come with the right investment choices for you, you might want to rethink where you put your money... like, maybe looking into an IRA,” says Lapin.
An IRA is individual retirement account that anyone with an earned income can open through a brokerage company. Unlike a 401 (k), an IRA does not depend on your employer; you set it up yourself and keep the account should you change jobs. Similarly to 401 (k), there are two types of IRAs to choose from: traditional and Roth. The traditional IRA may enable you to make tax-deductible contributions. The Roth allows you to contribute after-tax dollars so you can take tax-free withdrawals at retirement. “We generally recommend contributing to a Roth 401(k) if you have one available to you. Otherwise, contribute to your 401(k) up to the match if you have one and then the rest to a Roth IRA as long as you’re eligible based on the income limits,” says Farnam.
Lapin stresses the importance of maxing out both accounts every year. For a 401 (k), that’s $18,000 per year if you are under the age of 50 and $5,500 for an IRA. “The closer you get to that annual amount, the better off you’ll be down the road, especially if your employer matches,” she says. “I always think it’s best to contribute the same amount each month, so you can build it right into your budget, but whatever it takes to get you there by the end of the year—like if you’re expecting some graduation money or extra cash around the holidays, for example—go for it!”