Savings 101

Alden Wicker
Posted

You may not know it yet, but your savings account is like your best friend: Treat it well during the good times, and during the tough times it will be there to take care of you.

Unfortunately, many Americans aren’t treating savings accounts with the love and respect they deserve. 64% of Americans don’t have enough stashed away to handle even a $1,000 emergency expense. Hey, we get it. Between paying for gas to and from work and catching up with friends over dinner, it’s easy to think, “I’ll start saving when I get that raise.” But you’ll wish you had thought of little ways to save here and there the day you get that $1,000 surprise. Plus, the habit of saving can help you achieve dreams, such as taking a big trip to Argentina or buying your first home.

Read on to find out why saving is so important and how to do it.

Savings in a Nutshell

The official definition of savings is, basically, what’s left over when you subtract your spending from your income. But we think this definition doesn’t quite do savings justice, because it makes it sound like savings just happen. No way!

Savings should be the money you set aside before you spend. You should limit your spending to an amount that will allow you to save enough. In order to make this happen, you should send money from every paycheck directly to your savings account—it’s that important. (See graphic.) Once it’s safely tucked away, you can pay rent or a mortgage and everyday expenses.

So why is savings even more important than paying for, say, your dinner tonight or clothes you need for work? Mostly because doing so will stave off a panic attack if, God forbid, you lose your job. If that ever happens, you’ll want to focus on networking and sending out résumés—not packing to move back in with your parents. This kind of savings is called an emergency fund, and it’s at the core of any smart woman’s financial strategy.

But besides the fact that savings will help you when you’re down and out, you will love savings for another reason: If you save well, it can provide you with a down payment on an apartment with a view, a dream car or even the chance to quit the corporate life and launch your own business. (Maybe a macaroon shop?)

Why Women Need to Save

Once upon a time, women thought their parents or husbands would always support them financially, so they didn’t need their own savings. But the median age for a woman’s first marriage is now almost 27 … and as our mothers and grandmothers have been trying to tell us, you shouldn’t rely on your husband, parents or credit card to support you. It’s a recipe for disaster—and it won’t get you any closer to opening up that macaroon shop.

Even if you’re sure you will marry a fabulously wealthy man, having your own savings account means that you can ignore him if he disagrees with your car choice, that you won’t have to ask him to fund your dream business, and—hopefully this won’t be the case—that you can leave the relationship quickly if it turns sour.

Just consider these two facts: half of all marriages now end in divorce, and by one estimate, a woman’s quality of life drops 45% after divorce. Even happily married women tend to take time off from careers more frequently than men—mainly to have children. A savings account bridges that gap in income, especially with an expensive new bundle of joy in the picture.

Term Sheet

Emergency Fund
n. Money saved to pay for emergencies such as losing one’s job, unexpected medical expenses, essential home repairs and car repairs. Should be equivalent to at least six months of your net pay, or a full year if you’re a freelancer or have irregular income.

Interest Rate
n. In the case of a savings account, the amount paid to you by the bank for the privilege of holding your money for you. As of early 2012, a good interest rate for a savings account is about 1%.

How Savings Works

The best place for savings is not under your proverbial mattress but in a savings account, which is a bank account with interest rates that, while not incredibly high, are higher than what you will get in your checking account.

While interest rates can work for you or against you, in the case of savings, they work for you: When the bank offers you a higher interest rate on your savings than on your checking, that means it will pay you more for the money you deposit in savings than it will for the same amount you deposit in checking.

Essentially, the bank is paying you for the privilege of temporarily using that money, which it will loan to its borrowers. Because you’ve put it in savings, the bank assumes you yourself won’t be using it any time soon. (Read more about why banks do this and how interest rates work here.)

The difference between a 0.5% interest rate and a 1% interest rate may not look like much, but that difference snowballs because of a little concept called compound interest. (Read more about compound interest here.) When you’re saving up a sum of money as large as six months’ worth of expenses, that small percent difference could be $50 or more a year in interest that you wouldn’t have earned in your checking account.

How Much You Should Save

For Your Emergency Fund

Your emergency fund should give you at least a six-month cushion. By that, we mean it should equal six months of your net pay. So, if your paycheck is $1,000, and you receive two paychecks a month, your emergency fund should be $12,000. If you receive that same paycheck every other week, however, your emergency fund would be slightly bigger: $13,000, because you’ll receive an extra paycheck during that six-month period. If you’re a freelancer or you have a job situation that is not as secure for other reasons, we recommend saving even more than six months’ worth of net pay, such as a year’s worth.

RELATED: 5 Money Mistakes Even Good Savers May Make

If your lifestyle expenses go up, contribute more to your emergency fund until you have six months of your new net pay saved. And never use your emergency fund for other short-term goals like a trip or a dress for a family member’s wedding! Those aren’t emergencies.

For Your Goals

Once your emergency fund is stocked, decide what you want to save up for in the next year, or five or ten years. A car? A house? A gorgeous wedding and honeymoon in Paris? To figure out how much to set aside for your goals, you can either start with a deadline or the amount you’re able to aside per month. (To determine how much you should set aside, use our Get to Your Goal calculator.) You should also have a budget in mind for your goal, so you know whether you’re aiming to have a $2,000 week-long vacation in Sicily, or a $3,000 one.

In your savings account, set up sub-savings accounts for these goals separate from your emergency fund so you don’t start dipping into the latter. (And if your savings account doesn’t have sub-accounts, it should! Find out how to get one here.)

You Can Save! Here’s How

Hopefully by now you understand why savings are so important to a happy, stress-free life! But how do you start putting money in your savings account? It’s actually not that hard:

  1. Build a budget.
    A budget will ensure you never spend more than what you have. It will also keep you from getting into debt while you build your savings. (Read here about how to build a budget.)
  2. Keep your savings separate from checking.
    And by that, we mean to hold your savings at a separate bank from your checking account, so you’re never tempted to spend it on something that’s not an emergency and not a goal.
  3. Prioritize savings above all else.
    As we said before, deposit a portion of your income directly into your savings account, and then put just what you need to live on into your checking account.
  4. Separate your emergency fund from your savings goals.
    Choose a savings account that allows you to open sub-accounts so you can keep your emergency fund separate from your other goals.

Remember …

Saving is a core part of any woman’s financial health. And it isn’t as hard as you think. With a bit of planning and a smart budget, you can be confident in your financial future and reach your dreams.