Saving is all about transforming income into wealth.
Working and having a source of income is indispensable to financial security, but it’s only a first step. Smart budgeting and planning can help you build up surplus income each month that can be set aside for saving.
Most financial institutions offer several options for saving and investing your money, each with their own mix of risk versus return. Decide the level and type of savings that is best for you based on your goals, your timelines, and the composition of your financial portfolio.
How to make a savings plan
There is no one-size-fits-all rule for how much money you should save or where you should put it. However, everyone should have a budget, identify their savings goals, and make a savings plan to achieve their goals.
Here are a few rules of thumb for developing your savings plan:
- Start early. Saving is a habit, and the sooner you start saving the more your money will grow through compound interest.
- Build an emergency fund. A good starting point is to work towards building a fund with six months worth of expenses in liquid savings, for access in case of emergency.
- As your income increases, so should your savings amount. One rule of thumb, described on the budgeting page, is to put 20% of your monthly budget towards savings.
- Put your savings into accounts that align to your financial goals. The below section describes different types of savings vehicles.
Types of savings vehicles
Savings accounts are a very safe place to put your money. Your funds are insured and readily available in a branch or through an ATM. You will typically earn just a small amount of interest in these kinds of accounts, but because you can easily access the money you put away in a savings account, they are a natural choice for your emergency fund.
One downside to keeping a lot of money in a savings account is that the interest rate is unlikely to keep up with inflation. If you’re keeping a fairly small amount of money in the account, either for emergencies or a short-term goal, it probably won’t cause you much of a problem. If you have a larger balance and you plan to keep it long-term, an account with a larger return probably makes more sense.
Another challenge is that you may be tempted to use the funds for spending money or other expenses instead of saving for your goals, since a savings account is easily accessible. If this is the case, consider opening separate accounts for each purpose—one account for regular expenses, another account for your emergency fund, etc.
Certificates of deposit (CDs)
Certificates of Deposit (CDs), much like savings accounts, are a safe and insured savings tool. You’re more likely to get a better interest rate with a CD than with most savings accounts, but unlike savings accounts, you commit your money to the account for an agreed-upon period of time in exchange for that higher return. Rates vary based on market conditions and the length of the CD term, with a longer term generally generating a higher rate of return. If you have an emergency and need to get your money before the agreed-upon period of time, you’ll be hit with an early-withdrawal fee and may forfeit the earned interest.
CDs can be a great savings vehicle for medium-term savings goals. For instance, you may be planning to buy a car next year and want to set aside the money you’ve already saved towards that goal.
Money market accounts
Money market accounts are savings accounts that typically provide a higher rate of return, but may also require a larger balance. You may also have some check writing ability from these types of accounts.
Individual retirement accounts (IRAs)
IRAs are long-term retirement investment accounts. The earnings on these accounts grow tax-deferred. Aside from in a few special scenarios, you can’t access the funds until you are of retirement age without incurring penalties and tax consequences.
Other savings vehicles
Other types of specialized savings vehicles allow you to save for specific purposes and each have their own characteristics. For instance, 529 Accounts can be used to save for future educational expenses and have their own tax advantages.
The video below is a nice summary of the differences between savings accounts, investment accounts, and retirement accounts.
Types of banking institutions
There are a lot of choices when it comes to picking the right financial institution—national vs. local, online vs. traditional, bank vs. credit union. They each have their pros and cons. The articles linked below outline some important points to consider before selecting a banking institution:
Best practices for choosing a bank (MIT Student Financial Services)
How to choose the best bank for you
The pros and cons of banks vs. credit unions (Note: MIT students and staff are eligible to join the MIT Federal Credit Union)