Want to get rich? Save more of your paycheck.
People hate hearing that advice. They immediately fire back with a dozen reasons why they can’t do that. But personal finance follows simple mathematical rules, like laws of nature. These rules don’t care whether you build wealth or not, whether you have persuasive excuses. Your results come down to the simple math of your savings rate and your investment returns.
While investing is its own science, saving money is something we can all understand intuitively, even if we don’t like doing it. Still, it helps to know exactly what we’re talking about when we talk about “savings.”
What Are Savings?
When most people hear the word “savings,” they think of cash savings. That could be held in physical cash, in a safe or under a mattress. Or it could be held in a savings account, perhaps earning a little interest.
Savings can also refer to a broader pool of funds you’ve set aside, including investments. For example, people use terms like “retirement savings” and “life savings” to include their stocks, bonds, and other investments, not just cash sitting in a savings account.
Regardless of how broadly you use the term, “savings” refers to money you’ve set aside and can access relatively quickly in a pinch.
How Savings Work
Since most of us don’t win the lottery or inherit millions from rich uncles, we have to build wealth the old-fashioned way: by setting aside part of each paycheck.
Your savings rate refers to the percentage of your after-tax income that you put toward savings. If you earn $4,000 each month after taxes, and you save $1,000 of that, you have a savings rate of 25%.
From there, it could go to different destinations. Some of it might go to your cash emergency fund, some might go toward your retirement investments, and some might go toward paying down debts early. While most people don’t think of paying off debts early as a form of savings, it still boosts your net worth by reducing your liabilities and eliminating interest.
Regardless, it all starts with setting aside money from each paycheck. Look for ways to automate your savings, such as recurring transfers from your checking account to your savings account, or having your paycheck direct deposit split between your checking and savings accounts. Today, you can also use automatic savings apps if they help you save more.
Types of Savings Accounts
Among traditional bank accounts to hold savings, you have a few options, all of which are insured by the federal government up to $250,000 per account type, per institution. So if you have a savings account, a money market account, and certificate of deposit at the same bank, you can have up to $750,000 in total deposits and still get every penny back should the bank fail.
Each type of savings vehicle comes with its own pros and cons. Make sure you understand how a particular account type works before parking money there.
1. Savings Account
Consider savings accounts the default option for saving money in a bank account. These accounts come with instant liquidity — you can pull out money any time with no penalty. For emergency funds in particular, that’s crucial.
Some savings accounts pay interest, although temper your expectations. Even high-yield savings accounts rarely pay interest rates above 3%, which is significantly lower than the inflation rate. And some savings accounts charge monthly fees if you don’t meet a minimum balance requirement.
Don’t be afraid to open a savings account at a different bank or credit union than your checking account. This keeps your savings out of sight, and adds a little more friction when you go to transfer funds. Which helps reduce the temptation to raid your savings.
2. Money Market Account
Money market accounts combine the higher yield of savings accounts with the easy access of checking accounts, often coming with debit cards and checks. You can withdraw money from ATMs, just like a checking account.
Beware though: The best-paying money market accounts often come with high opening balance requirements. Many also charge a monthly maintenance fee if your balance falls below a minimum threshold.
Like other deposit accounts, the Federal Deposit Insurance Corporation (FDIC) insures your balance up to $250,000. Don’t confuse money market accounts with money market funds, however. The latter are not FDIC-insured bank accounts, but rather investment funds.
Check out these high-yield money market accounts offering the best interest rates currently available.
3. Certificate of Deposit (CD)
Certificates of deposit offer higher interest rates than savings accounts and money market accounts, but don’t offer the same liquidity. You pledge your money for a certain period of time and usually can’t take withdrawals early unless you pay an interest penalty. The exception: “no penalty” CDs that let you withdraw principal without penalty.
Because most CDs are less liquid than savings or money market accounts, they don’t work well as emergency funds or short-term savings that you might need to access quickly.
When interest rates are low, CDs tend not to make much sense as investment options. But when interest rates are high, you can earn decent returns with your money still guaranteed by the FDIC.
Scope out these high-interest CDs for financial institutions offering strong returns right now.
Why Savings Are Important
Do you ever want to retire? Then you know why savings is important.
But retirement savings aside, you still need an emergency fund. Life will always throw curveballs at you, from job losses to medical emergencies to car repairs and home repairs. These are the exception, not the rule — this month it’s the furnace that goes out, next month it’s your carburetor. That’s life, and if you don’t budget accordingly, you’ll find yourself flitting from one “hair on fire” freakout to the next.
You also probably have specific savings goals, such as saving a down payment for a house, saving for a car, saving for a bucket-list vacation, and so forth. Don’t lump all your savings together, or you’ll end up raiding the account for whatever need feels the most urgent in the moment, rather than your higher-priority long-term goals.
While savings accounts fall on the simpler end of the financial spectrum, many people have questions about how they should fit into their broader personal financial plan.
What’s the Difference Between Savings & Investing?
Savings is safe, at least from losses in the traditional sense. Assuming you don’t touch it, the balance in your savings account won’t go down, no matter what financial markets do. Your balance may lose value to inflation, but your nominal balance won’t shrink.
Investments involve risk, and can lose money. If you invest $100 in the stock market, you might very well have only $90 tomorrow. Or you might have $110 — investments offset your risk with the possibility of higher returns than you can earn on safe, guaranteed bank balances.
How Can I Begin Saving Money?
Start by looking at your current budget categories and what you spend today. Then create a new budget from scratch, starting with your higher target savings rate.
It helps to separate your savings from your operating budgeting from the very moment you get paid, so you aren’t as tempted to spend it. Ask your employer about splitting your direct deposit or set up automated recurring transfers for every payday.
How Much Money Should I Have in My Savings Accounts?
That depends on many factors. First, what is the purpose of the savings? For goal-specific savings accounts, such as saving up a down payment, set a timeline for when you want to hit that goal and budget accordingly each month.
For your emergency savings, it depends on how regular your expenses and income are. A government worker with nearly 100% job security doesn’t need nearly as much as a startup entrepreneur who doesn’t know if she’ll turn a profit this month. Likewise, if your expenses range unpredictably from $3,000 to $6,000 each month, you need far more in your emergency savings than someone who always spends $4,000 per month.
On the low end of the spectrum, aim for two months’ living expenses in your emergency fund. On the high end, aim for around a year.
What Is a Savings Rate?
Your savings rate is the percentage of your after-tax income that goes toward savings, investments, or early day payoff. The higher it is, the faster you build wealth.
Aim for a savings rate of at least 10% to 15% if you live a standard middle-class lifestyle and plan on retiring in your 60s. But if you want to build wealth faster, to build passive income streams and potentially retire young, aim for the moon.
My wife and I save around 65% of our combined income. We don’t mind living humbly today in exchange for building wealth fast.
If you’re new to saving money, start with the basics like cash emergency funds, even as you work on creating a budget with a high savings rate.
As you look for the best savings accounts or money market accounts, look beyond just annual percentage yield (APY). Consider fees, limits on expenditures and withdrawals, and how easily you can access funds.
Don’t write off online banks. Often they pay the highest interest, and some offer perks like ATM fee refunds so you can access your money from any bank’s ATM.
When in doubt, speak with a financial advisor about the best ways to save and invest money to meet your financial goals. If you can’t afford one, sit down over coffee with one or two of your friends who are savvy with money, and form a simple plan that you can follow month in and month out.