Young Savers – Automation as a Savings Tool
The first step of building wealth is spending less than you earn. As Warren Buffett put it: “Do not save what is left after spending, spend what is left after saving.” It’s simple advice, but a reminder to young investors that savings is a priority.
Automating your savings and expenses is one of the easiest ways to achieve that goal and set yourself up for long-term financial success. Doing this will take some initial time and work. However, this work will create a savings process that does not require much additional action once established. Below are four steps to guide you:
1. Determine your savings vs spending goals.
Starting with savings prioritizes savings goals over spending goals. You may ask, “What is an appropriate amount to save?” Consider trying the simple 50/30/20 approach. This rule only requires you to divide your expenses into three main categories: spending 50% of your after-tax income on needs, no more than 30% on wants and 20% on savings or extra debt payments.
If the 20% savings goal does not seem achievable for you yet, don’t let that deter you. It’s fine to start with a 5% or 10% goal and build towards a 20% goal. Deciding to save, regardless of amount, is your first victory.
2. Identify what you’re saving for.
Before you move to the next step, take time to think about your goals. For example, saving for retirement requires a different type of savings than the home purchase in two years. Rather than saving just to save, it’s best to first identify why you are saving.
3. Automate your savings and expenses.
Now that you’ve identified your goals, you can start automating:
- Checking accounts – Your paychecks are typically funneled into this type of account. This is generally where you source your spending. Otherwise, this account can be used as a distributor of savings. Use your pay date as a day to start automatic transfers to savings accounts.
- High-yield savings accounts – For dollars needed in the short term, like a reserve for unexpected expenses or an upcoming home down payment or car purchase, it is safest to keep these dollars in FDIC-insured accounts that will pay interest without being subject to the potential losses of stock or bond investments. Online banks like Ally, Capital One or Marcus generally offer higher yields than traditional brick-and-mortar banks and are still FDIC insured.
Bonus tip: For some, it’s best to have different accounts for different goals. For example, if you are saving for both a down payment on a house and a car purchase, you may find it easiest to bucket these dollars into two separate accounts. Go the extra mile by naming the accounts with the respective goal to keep it top of mind.
- 401(k) – Many companies offer their employees a 401(k) plan. This is one of the best ways to automate your savings. Some companies even match a certain amount of your overall contributions. You can allocate a certain percentage of your paycheck to automatically deposit into your 401(k). Once you set this amount, avoid the common mistake of not electing investments for your savings. Realize that these dollars should be earmarked for retirement. There is a penalty associated with withdrawing before age 59 ½ (or 55 in certain cases), so keep that in mind when determining the amount.
- Roth and Traditional IRAs – These are additional vehicles to help with savings and their availability can depend on your income level. If you are eligible to make contributions to these accounts, many custodians allow for automatic monthly deposits. Set these deposits up to align with your paychecks, so you never have the chance to spend it. Similar to a 401(k), there is a penalty if you withdraw too soon, and there are contribution limits. Confirm eligibility with your tax adviser before contributing.
- Brokerage account – If you’re looking to save for a moderate time horizon or a longer-term time horizon with more flexibility, the personal brokerage account is an option for you. Within this account, you can buy mutual funds, ETFs, individual stocks and bonds. You can set these deposits up to align with your paychecks, so you never have the chance to spend it. The benefit to this account versus the retirement accounts mentioned above is you can access it at any point without any penalty, although you’ll pay taxes on income and capital gains.
- Fixed costs – The benefits of automation don’t stop at saving. By automating your fixed costs (i.e., rent or mortgage, car payments, credit card, cable bill, etc.), you can ensure you don’t miss a payment date or get charged a penalty, saving you money and time.
- Credit cards – Credit cards may have formerly had a negative connotation to them, given the ease of spending more than you can pay coupled with notoriously high interest rates. The key to using a credit card wisely is to treat it like a debit card and avoid spending more than the cash you have available and setting up automatic payments to pay the full statement balance in advance of the due date to avoid interest. Responsible credit card usage helps build credit history. However, if you don’t feel you can control having access to a credit card, then the benefits of a credit card do not outweigh the risks of having one.
4. Feel comfortable with responsible spending and review periodically.
Now that you have created a process around your savings that ensures your goals and bills are being met, you will begin to feel more comfortable with the occasional extra purchase. You can buy those concert tickets for that band you’ve been wanting to see or buy those new shoes you’ve been eyeing without guilt because you know you won’t dip into your savings. To stay on track, plan a quarterly review for yourself. You may even find that you have a little extra cash building and you’re ready to increase your savings!
The material shown is for informational purposes only and should not be construed as accounting, legal, or tax advice. Altair Advisers LLC is a registered investment adviser with the Securities and Exchange Commission; registration does not imply a certain level of skill or training. While efforts are made to ensure information contained herein is accurate, Altair Advisers cannot guarantee the accuracy of all such information presented. Please see Altair Advisers’ Form ADV Part 2A and Form CRS at https://adviserinfo.sec.gov/ for additional information about Altair Advisers’ business practices and conflicts identified.