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Often times people know that they should be saving, but they’re not quite sure where to invest first. This guide will help you know how much you should be saving and where that money should be put to maximize your earnings.
How Much to Save
Everyone has different savings goals and time horizons. However, the most important thing is that you start saving. As a general rule of thumb, putting 20% of your earnings towards your savings goals is a good place to start.
For some, saving 20% is difficult, for others it’s a bit easier. However, my suggestion is this: assume you must save at least 20% of your income and then rebuild your lifestyle around that. If you realize you’re only able to save 5%, chances are you need to find some places to cut back in order to meet your long-term financial goals.
Of course, everyone’s situation is different. Fresh out of school, your income is likely lower than it will be later in life, so it may be harder to save (but of course, the more you can save now, the more time your money has to grow). If you’re a bit older, use a retirement savings calculator (like the one at Personal Capital) to figure out if you’re on track or need to save more.
In the below example, we show the difference between starting to invest at age 25 vs. later in life. Starting at age 25 vs. age 35 could mean the difference of $1 million or more for an individual contributing $750/month to their investments.
Where to Save & Invest First
Now that you’ve decided to tuck money away each month, the next question is where should you be saving. Here are some general rules of thumb:
1. Pay Down High-Interest Debt
Your top priority is to pay down expensive debt – things like credit cards. If the interest rate on a credit card is 15+%, the odds of earning more than that consistently in any investment are slim. So pay down this debt as soon as possible. Note that I am not talking about inexpensive debt (mortgages, some student loans, etc.), as many investments have proven to earn more than this over the long-run.
2. Build your Emergency Fund
If you don’t have an emergency fund that covers at least 3-6 months of expenses, this is your next priority (see ideas for managing your emergency fund). Without an emergency fund, one small hiccup will send you back down the debt spiral.
3. Max out Your IRA
If you’ve completed steps 1 and 2, it’s time to start investing. My absolute favorite place to put money is in an IRA account. Both traditional and Roth IRA accounts offer tax advantages (check out the differences), so they’re a fantastic place to start. As a first step, try to max out your IRA account. For 2022, the contribution limit (across all your IRAs in total) is $6,000 or $7,000 for those age 50 or older.
Many will ask why I suggest maxing out an IRA before a 401(k) account. Two reasons: fees and flexibility. Many 401(k) accounts charge various forms of fees, eating into your returns. Additionally, 401(k) investment options are limited – some are good, some are not. But investing in an IRA allows you to pick the best possible investment options (think rock bottom fees and significant diversification).
If you’re looking for some specific guidance on choosing investments, check out our post on how to invest in mutual funds.
4. Max out Your 401(k)
Once you’ve maxed out your IRA, it’s time to try to max out your 401(k) account. 401(k) accounts also offer tax advantages, and many employers now offer both traditional and Roth 401(k)s. For 2022, the contribution limit is $20,500 (plus catch-up contributions for those age 50 or older).
Bankrate offers an awesome calculator that shows just how valuable tax-advantaged accounts are relative to taxable accounts, so be sure to max these out first. You can also check out our guide on how to invest in your 401(k).
5. Invest in a Taxable Brokerage Account
If you’ve made it this far, you’ve paid off high interest rate debt, have a solid emergency fund, and are saving at least $25,500 per year. That is a fantastic step towards your financial goals and you deserve a pat on the back! However, to keep saving more, the next place to turn to is a taxable investment account. Here you can invest as much as you want, as there are no tax savings associated with these accounts. Regardless, the more that can be saved, the better!
Check out our review of M1 Finance, one of our favorite brokerage account options!
Track your Investments
One trick to making the most of your savings and investing goals is to track your accounts.
Setting savings goals and seeing how your investments are performing can help you stay on track. The best way to do this is to use an automated tool that simplifies tracking.
The tool we recommend most commonly for this is Personal Capital. It’s what we use, as it has a slick interface and can tell you a ton about how well you are doing in reaching your personal finance goals. You can check out our comprehensive Personal Capital Review to see if it’s right for you!
The most important thing when it comes to saving & investing: Start Now
No matter where you choose to save, the most important thing is to start as early in life as possible and to save as much as you can. However, knowing where to invest first can make a big difference in building financial security. Once you’ve decided to save, use those savings to pay off high-interest-rate debt and build an emergency fund. When you’re ready to invest, start with tax-advantaged accounts, using taxable investment accounts only when you’ve exhausted all tax-advantaged options. If you’re looking for some guidance on getting started, check out our guide How to Start Investing: A Beginner’s Guide. And finally, if you’re already on track with all of your near-term goals, check out our post on five long-term financial goals to consider!
Are you saving 20% of your income and maxing out the opportunities mentioned above? Let me know in the comments below.