When you have more money to work with, you have the opportunity to start making it work for you. There are a lot of different options for taking care of your money that can provide different benefits depending on when you need that money.
Day-to-day
Checking Accounts
So most people use a checking account for their day to day expenses. This is great for two main reasons: no maximum number of transactions, ease of use with an ATM card. Checking accounts should not hold more than you need to get by in one month.
The cons here come in when you try to use this for your savings as well. Checking accounts usually earn no interest. They are also more likely to be stolen if you carry it around with you every day. If someone uses your card to make a large transaction or withdrawal, you can definitely dispute it and probably get your money back, but it may take a long time and a lot of hours on the phone with customer service. Also, if you have a fee with your checking account, you may want to see if you can have it waived, or consider switching to another bank.
Savings Accounts with your regular bank
These are commonly touted as “good to have” but they often come with more caveats than people realize. Many banks have a minimum balance for their savings accounts or charge a monthly fee. Interest rates are nominal, usually less than 0.1% APY. That means with a $1000 balance, you will earn $1 after a full year. Many savings accounts also have a transfer limit of 6 transactions per month, which can be troublesome if you find you need to pull money from there a few times due to unforeseen circumstances.
The benefits of a savings account with your regular bank can be easily replaced by having a second checking account and not keeping a debit card with it. You can still transfer easily from savings to checking and back in case of an emergency or overdraft, but with no limits or fees. Again, if your bank charges fees for checking accounts, consider switching.
Keeping a savings account with your regular bank (or a checking account used as savings) is great for your first emergency fund. When you are working with a tighter budget, you need to be able to transfer money in case unknown expenses pop up (Hello annual amazon prime charge!) and I recommend keeping a relatively low amount here, such as your first baby emergency fund, never more than $2000.
Emergency Fund
Your initial emergency fund should be immediately accessible with your regular bank, probably in a second checking account, see above.
There are a lot of different things to consider about your emergency fund. I usually consider it in two phases. The first phase is that initial $500-2000 (You decide what’s best for you) that you need before you start focusing on paying off consumer debt. This must be done before anything else, to avoid leaning on credit in case of a real emergency.
This initial emergency fund is also a big deal if you ever try to get a credit card “for the reward points.” I always tell my clients, if you want to reap the benefits of points, you CAN NOT carry a balance over! Know that any purchase you cant cover with your regular income will come from your savings when you pay off your credit card. I also recommend paying it off every pay period, instead of every month. If you carry a balance over, that 20% APR is going to massively outdo your little 1.5% cashback real quick.
High Yield Savings Account
A HYSA is an account with an online savings bank that can afford to offer these higher rates due to not having a brick-and-mortar presence. When shopping for a HYSA, make sure you check for:
- APY- these change with the market, increasing and decreasing regularly. This is not the stock market though, your personal balance will not go down, you will just earn more or less interest on that balance. Eg: a 2% interest rate on that same $1000 balance as your regular bank’s checking account will earn you over $20 over the course of that year.
- FDIC Insured- usually up to $250,000, this ensures that your balance is yours even if your bank goes bankrupt.
- Minimum balance- some accounts have a minimum balance to earn the advertised interest rate.
- Minimum monthly transfers- some accounts require automatic monthly transfers to earn the advertised interest rate.
- Any other qualifications you may not be comfortable with.
The second phase is your full emergency fund. Once all your consumer debt is paid off, or at least everything with over 4-8% interest(more on those numbers in a moment), then you can start working on your full emergency fund. This is your,
“I lost my job and I still have to pay rent” “I’ve been in a car wreck and emergency room copays are still huge,” “It’s the apocalypse and I need to buy a bunker” fund. Financial bloggers often quote anywhere from 3-12 months of expenses in this fund. I’d like to clarify, this is emergency expenses. These include needs only, such as rent, utilities, gas, and groceries. I usually tell people to start with a 3-month goal and then reassess their priorities as they reach that goal.
Some things like cars, student loans, and mortgages that are in this 4-8% range are less urgent because you may earn more by investing extra payments in the stock market. Of course, this only works if you actually do invest it! Most people don’t, and to them I say, pay off that debt! If a decreasing debt balance is more motivating than an increasing savings balance, do that.
Mid-term goals
Mid term goals are usually anything from 1 year to 10 years away. HYSAs are also great for mid-term goals, such as saving for a car,a home down payment, or a big vacation. Some online banks allow you to get multiple accounts so you can personalize them with the name of the goal, amount, and timeline.
Certificates of Deposit
CDs are another good option. CDs usually offer a higher interest rate than a HYSA, fixed. Because of this, long-term CDs may end up earning less because rates may rise again in a short time. CDs often offer .5-1% higher than HYSAs, so your same $1000 balance in a 1 year CD at 2.5% would earn $25 in a year, or 3% would earn $30 in a year. You can not add money to a CD while it is in progress, and you cannot take it out without penalty, so you would only use this for goals that are on a longer timeline than the CD rate.
CD Ladder
Because of this, many people employ a CD Ladder method. This means you take your saved balance, divide it into equal parts, and create separate CDs that expire on a regular basis. You can renew the CDs at whatever the current CD rate is, or take your balance with your earned interest if you need it. For example, if you had $10,000 for your kid’s future college fund, you could separate it into 12 $800 CDs, each one month apart. So every month, one of your CDs would mature, and you could either renew it or add to it at the current CD rate, or you could take that matured balance and use it wherever you like.
Long Term Goals
Long term savings goals are more than 10 years from maturity. For example, Retirement is usually a long-term goal. I separate them this way because 10 years is usually enough time to start withdrawing funds from the market while working around it’s inevitable ups and downs. This still depends on your risk tolerance. You will, at some point, watch the market drop dramatically and all “your money” will disappear in a heart-attack causing panic. However, the market always goes up if you give it enough time to recover, so far.
Roth IRA
A Roth IRA (Individual Retirement Account) is an account that is available to an individual without respect to any employer. Contributions to a Roth IRA are always after your income has been taxed, and all future withdrawals are tax free. As of 2020, you can contribute up to $6000 per year. If you are over 50, you can contribute up to $7000 per year. There is an income limit on Roth IRAs, if you are an individual making more than $139,000 or a couple making more than $206,000 per year, you are not eligible to contribute to a Roth IRA.
401K
A 401K is a company-sponsored, tax-advantaged account offered by many employers. You can choose to make contributions before tax (traditional) or after tax (roth). If your employer offers a match, it is nearly always before tax. They usually offer anywhere between 50-100% matching of 1-6% of your income. You must contribute that percentage to receive the match. Employer match is usually the best ROI you’ll ever get. It’s guaranteed (depending on your company’s vesting policy) and usually a simple addition to your portfolio balance. You can contribute up to $19,500 in 2020, and if you are over 50 years old, you can contribute up to $26,000.
403B
A 403B is similar to a 401K but is usually only available to employees of public schools and tax exempt organizations. You may be eligible for a 403B in addition to your 401K, and increase your ability to save money pre-tax.
Health Savings Account
An HSA is another tax-advantaged account that you may be able to take advantage of in conjunction with your insurance plan. If you have an HSA through your employer you can receive triple tax benefits. This means your contributions are pre-tax, you wont be taxed on account growth, and when you use the money from the account to pay for health-related expenses, you wont pay taxes then either. An HSA rolls over year to year so you don’t have to worry about losing your savings. As a side note, this may reduce the amount you need in your Emergency Fund, if you were considering health-related expenses in your needs.
529 Account
Another tax-advantaged account, 529 plans are to be used for education costs. If you are considering starting a college savings fund for your kids or grandkids, check out how these tax advantages and market growth may help further your goals.