Your personal savings journey starts with good savings strategies! Savings gives you the power to make choices. Choices are the most inspiring changes of your life because they are made by you! Let’s get the chance to make some good choices and good changes through good savings~!
Three Important Information Barriers to Good Savings
This post will highlight three important concepts with regards to savings:
- Where to Save?
- What to Save?
- How to Save?
But first! Budgeting
This is the most important step – I detail it very clearly in a previous post here Financial Plan but I will continue to reiterate that if you do not know the money you are making, you can’t plan for the money you can save!
Where to Save?
The Answer: Interest Earning Accounts
Take a moment to look at your bank accounts that you currently have (this can be a deeply impactful or even spiritual experience for some so take the time you need).
Do any of them actively earn interest?
What is Interest?
Interest is the money paid for delaying the payback of lending of money.
Most people know of interest from Mortgages, Student Loans, or Credit Cards. The interest is the financial institution collecting money from you in exchange for not collecting your full debt in one lump sum.
Interest you earn on a savings account is a payment to the account holding consumer who allows the financial institution to borrow your deposited money as capital – money they can use for their business purposes – while it is deposited. It’s still yours, but it is reflected as money for the financial institution business purposes – such as lending money to others to collect on interest. Can you see a bit on how financial institutions do business now?
While we are on the topic:
On bank rate sheets for these accounts, there are a lot of acronyms. Two in particular come to mind. What is the difference between these acronyms Annual Percentage Rate (APR) and Annual Percentage Yield (APY)?
Short answer is:
Yield (APY) is the amount of yearly interest you earn on the money deposited.
Rate (APR) is the yearly cost of borrowing money – for example from a loan.
When looking at savings accounts, we care about the APY – the annual amount of interest yielded on an account in a year when held for a year.
For borrowing money: remember that APR does not take into account all fees on a borrowed sum. So remember that you will most likely be paying over the amount of the APR based on financial institution fees. These fees are different everywhere. This is why you always shop around before you borrow money!
There are multiple types of accounts you can save in for your personal savings goals:
High Yield Savings Accounts (HYSA)
High Yield Savings Accounts (HYSA) are accounts which provide just that, a high yielding interest paying account for funds saved. This is a good account to look for to keep larger sums of money saved, such as an emergency fund that you are gonna go start after finishing reading here, right? 🙂
The benefits of these accounts is that the money remains liquid – you can always access it if you need it.
The drawbacks are that the APY is variable – it can always change based on how the market is doing.
Important to note: These accounts are designed to trend inflation so that the money in the account does not lose its dollar value even though inflation goes up. It is not designed to earn you money, though the dollar amount in the account goes up, the value of the dollars in the account trends the value of the economy.
Certificate of Deposits (CDs)
Certificates of Deposit are another tool for savings. These accounts are also used for larger sums of money, but are different from HYSAs.
The benefits of these accounts: the APY is set at the time of deposit and will not change. Oftentimes the financial institution will run deals on CD APYs when they are looking to increase available capital for loans and interest collecting (for example with a high influx of consumer mortgages for a particular season).
The Drawbacks of these accounts: the money is locked into the account for a set time as per the agreement at the time of deposit. Early access to the money is possible, but with heavy fees and penalties.
Traditional Savings (Savings)
These basic savings accounts are used for very short term money holding. Perhaps you are going on a trip next week or are purchasing a new dresser and need to put money away.
These accounts earn practically no interest (most banks are in the 0.01% interest paying range). If you plan on saving for any degree of time, look into other account types.
Let’s talk about Compound Interest next – this is the biggest powerhouse of savings and investment!
Compound Interest:
Compound interest is the interest earned on the interest previously paid.
Let me illustrate a visual example. I am a very visual person.
Let’s say we start with $10,000.
Our return rate (aka the yield on our savings) is 3.4%
We deposit $500 per paycheck biweekly (so $1000 a month)
We continue this for one year. Compounding daily (the interest calculates everyday)
If you take a look at the chart. You will notice something interesting.
You can also see the interest is growing every month and that our ending balance is also growing every month by both the deposit amount and the interest earned.
Compound interest means – you continue to earn interest on not only the amount you contribute to the account (the deposit) but also the interest earned in the account.
For the first month, we only earn 3.4% interest on $11,000 dollars.
The second month, we earn 3.4% interest on $11,028.37
Interest is paid based on the interest we’ve already earned. That is the power of compound interest.
For the sake of really driving this point home. Imagine we continue our previous example for 30 years – roughly the average working time an individual has in their lifetime.
This is the power of compound interest – and it applies not only to savings accounts, but also to retirement accounts like 401k, Roth IRA, 403b, etc. and other investment accounts. Hopefully this topic excites you – as you save more or invest more, you have the potential to without changing anything at all!
For those of you who like playing with investment/interest calculators: I really like this one from calculator.net. It gives a solid way to visualize a financial choice prior to making it.
For those of you smarties out there who already take advantage of interest bearing savings accounts and are thinking “what about investment accounts? They have the potential to make more than this especially with large interest compounding over time in a well diversified portfolio to minimize risk”. Good point and wonderful segue. This post is focusing on only accounts which are not investment accounts. We are highlighting Personal Savings not Potential Earnings. I cover those in another post as they are a bit more complicated than interest.
What to Save?
The Answer: Emergency Fund, Retirement, and Big Purchases/Investments
I have highlighted an order for savings and investment in the Financial Plan Post here, but summarized it goes as follows:
- Budgeting
- Emergency Fund 3-6 months monthly expenses
- Start Retirement Investment (401k Match with employer)
- Debt Payoff (All consumer debt minus Mortgage)
- Refining Investments (IRA, HSA, Taxable)
- Personal Financial Goals
Please see the Financial Plan post for details! 🙂
How to Save?
The Answer: Automate Everything!
There are several ways to automate your savings.
Good – Set an automated transfer from your bank account to your savings account every month. This ensures you save without having to actively make the choice every month to save.
Better – Some employers offer multiple account deposits for direct deposit. Set a direct deposit for a flat amount (say $100 to start which you can increase slowly as your income rises)
Better still – Establish a High Yield Savings Account from a financial institution separate from your main checking account location. Set up a direct deposit from your employer from your paycheck to this account. This minimizes the chances of you accessing your personal savings except for emergencies because it is more effort to do so! Use that mildly lazy streak to your advantage!
Personal Savings Is A Journey
Personal savings is a journey – a marathon and not a sprint for those active people out there. The journey requires building mental muscle to do and to learn techniques that work with your personal psychology.
Start your savings today!
The fact you are reading this today means you have the desire to change something. Today is a choice. Hopefully the information provided here gives the tools needed to help make the best, most positive, and lasting choice to make the changes for which you are looking!
From my mind to yours!
~Jay
I enjoy sharing what I have learned through my own personal finance journey!
