If you want to know whether a dollar saved today will really be worth more than a dollar saved tomorrow, let’s take a look at this simple math:
If you invest one dollar at age twenty, it will be worth $21 by age sixty, assuming an average return of 7% over the years. If you wait until age thirty to invest that same dollar, it will be worth $10.68. Start at age forty, and you’ll have $5.43. Wait until you’re fifty to invest that same dollar, and you’ll only have $2.76.
So, a dollar invested at age twenty is almost twice as productive compared to a dollar invested at age thirty, and more than 7.5 times as powerful as a dollar invested at age fifty!
If you have already started saving money, the time to start is today. Every day you wait costs you financial peace in the future.
You need to remember that you should have a plan to make the most of the money you save. One of the best plans to maximize your savings is the investment sequence, which determines where you put your money and in what order.
Investment Sequence to Grow Investment Savings
Start at level one and work through this list to begin building a strong plan for your money.
Level 1: Emergency Cash Reserve Savings
At the very top of your investment sequence should be your emergency cash reserve savings. You should have enough cash to cover three to six months of fixed expenses, and it should be kept in a money market account, high-yield savings account, or other very liquid investments. Use this money only for genuine emergencies like job loss or major healthcare costs.
Tip: When considering high-yield savings accounts, be sure to check the initial deposit amount and the minimum balance requirements needed to earn interest and any monthly fees.
Level 2: Short-Term Cash
The next level is short-term cash, which should cover expenses due in the one to three-year timeframe. These savings should not be confused with emergency savings. This money should be used if you have a known large expense coming up in the next 12 to 18 months, such as a down payment on a home or a new roof. Your emergency fund does not need to be depleted due to a planned financial event, even if it’s a year or a year and a half away.
Tip: If you have a specific timeline for when you will need to tap into short-term cash, look into certificates of deposit as a savings option. CDs can offer higher returns than regular savings accounts, although withdrawing them before their maturity date may incur a penalty.
Level 3: Maximize Employer Match in a 401(k) Plan
You should strive to make your contributions to a 401(k) plan at least equal to what your employer will match. For example, if your employer matches 6%, you should contribute at least 6% yourself. If you are unsure about the minimum contribution required to qualify for the full match, HR or the plan administrator should be able to help you.
Level 4: Roth IRA Account
Next, start funding a Roth IRA and aim to fully fund it. Contributions are made after tax, and you can withdraw them at any time. Make sure to know how much you can withdraw without paying a penalty. Once you reach age 59 and a half, all withdrawals are tax-free. Importantly, unlike a traditional IRA which requires minimum distribution withdrawals at age 72, there is no mandatory distribution age with a Roth IRA.
Note:
The ability to make contributions to a Roth IRA depends on your income and tax status. If you are unable to contribute to a Roth IRA, you may consider investing in a traditional IRA instead.
Level 5: Maximize Your 401(k) Plan
After funding your IRA, go back and maximize your 401(k) plan. If you cannot afford the full annual maximum contribution, think about how to increase the amount of money you put into your 401(k) plan over time. For example, you may be able to automatically increase contributions each year. If contributions are increased at the same time you receive a raise, you may not even notice the extra money coming out of your paycheck.
Level 6: Taxable Investments
If you’ve done all of the above and still have money to save, you can put that money into a brokerage account. Whether you manage your money yourself or have someone else manage it, be sure to have a diversified portfolio that will earn dividends, interest, and capital gains.
When considering online brokerage accounts, look at the range of investment options they offer as well as their minimum investment requirements and fees. If you don’t have a lot of money to invest, you may want to stick with low-cost, tax-efficient index funds to stretch your dollars further.
Important: The money in a brokerage account is not treated the same way as money in a 401(k) or IRA from a tax perspective. Your investments are subject to capital gains when sold, which must be reported when filing your annual tax return.
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Sources:
Internal Revenue Service. “Traditional and Roth IRAs.”
Internal Revenue Service. “Topic No. 409 Capital Gains and Losses.”
Source: https://www.thebalancemoney.com/how-to-maximize-your-investment-savings-1289921
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