Savings as a Source for Wealth
[dropcap background=”” color=”” circle=”0″]T[/dropcap]here are a number of ways to build wealth. The two main methods people tend to think of are through your career and by investing. Saving money definitely deserves its place in a wealth-building strategy too. No matter how much you make or invest, chances are this is an area of your financial life you could improve.
Getting Your Priorities Straight
Long before you can start putting money into a savings account—or investing, for that matter—you need to get your priorities straight. Begin by allocating money to take care of debt. For most people, credit card debt is a huge liability. Younger people also probably have student loans to worry about if their amounts are piling up. Whatever the case, these liabilities need to be targeted first.
Only after that should you start focusing on saving money and only after that should you begin investing.
Strive for Financial Independence
Overall, your guiding priority should be reaching “financial independence”, not getting rich. We define financial independence as a point when your passive income is enough to handle all your expenses.
Saving for the Sake of Wealth
If you’re in a place where debt is no longer an issue, then you should next focus on cutting your spending so that it is deeply below what you make. Begin to take pride in how much more of your monthly income you get to keep than the amount you have to spend. At the same time, though, realize that cutting costs is rarely how people find themselves wealthy.
How Much to Save
How much you actually need to save will depend on a few factors, like how much you need to live on, any future expenditures you’re planning, when you wish to retire, etc.
A safe recommendation, though, is to save 20% of your paycheck. Then, cut that 20% up into other forms of saving to maximize your benefits. Examples of this are below.
A Rainy Day Fund
This is an essential form of saving everyone should have. You want to have at least three months—though six is preferred—worth of money on hand in case something happens that stops you from earning. The money needs to be enough to cover your costs and anyone else who relies on you for support.
Benefit Plans
Many countries offer a variety of different benefit plans. For example, in the US, 401(k)s and IRAs are tax-advantaged accounts designed to help individuals save for retirement.
If your company offers a 401(k), set money aside to max it out. This is free money for those who take advantage of the opportunity. Companies in other countries often have similar vehicles available, which allow an employee to contribute to their pension with money from their own paychecks before it’s ever taxed.
The same goes for IRAs. There’s no reason not to make the maximum contribution if you can afford it. Tax-advantaged accounts and employee benefit plans are in general always something you should take as much advantage of as possible.
Investments
Finally, with the above areas covered, you should have enough money to begin investing in your future. In the US, 529 plans or other tax-advantaged investment vehicles focused on college costs make a lot of sense if you or a relative will likely incur educational expenses in the future. Otherwise, mutual funds are a great and safe way to go.
Saving money may not make you rich overnight, but its importance to wealth building cannot be overstressed. The earlier you begin, the more success you’ll have, especially if you follow the above advice.