Saving money is the core pillar of personal finance. It teaches you how to live below your means. It also demonstrates the importance of planning for the future.
But, how much should you save? How much should you invest? And what type of accounts should you be doing it in?
One of the things I’ve become more used to as my career has gone on as an investment advisor is the fact that there are no blanket answers that apply to every single situation. And the key to getting good, relevant, answers is asking questions that get to the heart of the matter.
So, when people ask “how do I balance saving money and investing for the future?”, the answer depends on your cash flow and your goals.
The easy, blanket answer on how to save for retirement is to do so in a retirement account like a 401(k). Your dollars grow tax deferred and your contributions lower your tax bill. For a lot of people that are just getting started in their careers, a company 401(k) plan is their first experience with investing.
For the most part, contributing to a 401(k) is great. Especially if there is a company match involved. That should *almost* always be taken advantage of.
But you shouldn’t just be blindly piling in as much as you can. There are other considerations that need to be made.
Like the fact that you can’t access your 401(k) money until you are 59 1/2 years old. And there are early-withdrawal penalties if you do so. Plus you have to pay tax when you take the money out. It can be done. But it is far from ideal.
Life is rarely ideal. But we have to strive for something when making financial planning decisions. It’s easy to strive for goals attached to a number. Like I want to have $100,000 invested by the time I’m 35. Or something like that.
What is difficult to strive for, because it’s intangible, is flexibility.
This is what is often uncovered when asking questions throughout the financial planning process.
We’re hearing more and more, that what folks really want is flexibility. Whether that means they want the option to retire before age 59 1/2 and need to access their money. Or someone who is early on in their career and wants to save money for a first time home purchase, but doesn’t know when they can realistically do it.
Stockpiling cash in a savings account gives you the most financial flexibility. But we know that things will cost more money in the future. Accumulating excess money in a savings account, past a certain point, rather than an investment account is risky in its’ own right due to the erosive power of inflation.
On the other hand, risking money that is earmarked for spending in the near term isn’t a good idea either.
So the question then becomes, how do we remain flexible while still investing our money for the future?
This decision is all about trade-offs. What do you value more? It’s not an either or decision. As you can both save for retirement and save for the short term. But the answer indicates which area you should devote more dollars towards.
A checking or savings account gives you the most flexibility. But you miss out on potential growth in the stock market. If you want a guarantee that the money will be there in 1-3 years, this is the way to go.
A tax-deferred investment account, like a 401(k) or an IRA allows you to contribute pre-tax dollars for potential growth, but it ties your money up until age 59 1/2. These dollars are long term. Don’t touch these until you are not penalized to do so.
A Roth IRA or 401(k) allows you to contribute post-tax dollars, it still ties your money up until age 59 1/2 BUT you can take out your contributions if needed. Should still be viewed as long-term and in case of emergencies only.
A regular taxable brokerage account allows you to invest in the stock market with no contribution limit. There is no tax deferral, and you will pay capital gains on the investments if you are to withdrawal the money. But you can access it if you need to with no penalties. Not the most efficient way to invest, but a solid medium term option that is often overlooked. You have to be willing to risk this money, though. Because investing is never a guarantee.
If you have excess cash flow at the end of each month, and want to start saving. Separating the dollars out into short, medium and long term could prove useful. Let’s say you have $2,000 left over each month. And you want to buy a house in 2 years, while also saving for your retirement. You could save 70% to a savings account ($1,400), 20% to your 401(k) ($400), and 10% to a brokerage account ($200).
Only you will be able to determine what works best for you. But this way you are both keeping an eye out for tomorrow, while addressing your more pressing needs today.
Your answer to the question of “what do I value more? Short term flexibility? Or long term goals?” will tell you where to direct your dollars. And the beauty of all this is, it can (and should) change when your life changes!