Saving for a big expense can help you to afford things that you could never buy out of ready cash.
Some things are pretty much impossible to finance with the cash you have on hand at the time. So, unless you want to go deep into debt, saving money in advance is a necessity. While you could save for a big purchase just by stuffing money in a bank savings account, that’s not really the best use of your cash, given that bank savings accounts pay a minuscule rate of interest. Instead, consider using an account that will help your money to grow even as it sits there — the more money that your money makes for you, the less you have to save to finance your big purchase. Here are some common major expenditures and the best ways to save for them.
Your retirement is likely the biggest single expenditure you’ll ever make.
Fortunately, the government has come to your assistance by creating several tax-advantaged accounts designed specifically for retirement savings. The various forms of IRA and 401(k) accounts let your money grow tax-free, meaning that you’ll make substantially higher returns than you would from the exact same investments in a standard brokerage account. In fact, these accounts are so good for savers that the IRS has put contribution limits on them to keep you from hiding all your money away from the agency.
Because growth is the name of the game when you won’t need the money for decades to come, the majority of the funds in your retirement accounts should be in stocks right up until your 50s or even 60s. Even though stocks tend to be more volatile than bonds, they have a higher rate of return over the long run. The high long-term growth you can expect from the average stock investment will save you a bundle on how much you need to set aside from your income.
Kids are expensive, and the costs don’t stop when they turn 18 and head off to the university of their choice. As with retirement, the advantage you have while saving for your kids’ college expenses is that you know exactly when you’ll need the money. That means you can stick the money somewhere relatively inaccessible for a while, where it can get the highest possible rate of return, and also choose volatile investments like stocks knowing that the account will have plenty of time to recover from any unfortunate market downturns. Coverdell Education Savings Accounts (ESAs) are a great choice for tucking away money for education, although you can only contribute $2,000 per year per beneficiary. Depending on when you get started saving, that might not be enough, so it’s fortunate that you also have the option of the 529 college savings plan, which lets you save up to $14,000 per year. Neither type of accounts gives you a deduction for contributions, but both allow the money within the account to grow tax-free until you use it.
Saving enough for a down payment on a house can be quite a task, especially if you’re shooting for a 20% down payment. The best type of account to use for such an expense will depend on your time frame. If you plan to buy a house within the next year or two, for instance, you’ll want to keep the money somewhere easily accessible — say, an online savings account (we picked the best high-yield savings accounts) or a treasury bill of the appropriate maturity. If you’ve got a longer time frame of, say, five years or more, consider putting part of your savings into stocks. While there have been exceptions, five years is usually enough time to get a very good return on stock investments; but because that’s by no means a sure thing, don’t commit all your down payment money to the stock market. Keep the majority of it in a less volatile investment, such as a money market account with a high rate, high-yielding CD, or high-quality bonds that will mature before you need the money. Check on the interest rates for these various options to see which one is the best bet at the time you’re ready to start saving.
While the above expenditures are likely the three biggest you’ll ever make, plenty of others may come up during your lifetime that require some saving to make them happen — everything from your dream vacation to the uber-gaming computer system that you’ve always craved. When saving for the short-term, you can’t count on interest or other returns to make up a significant portion of what you need, so it’s important to have a disciplined savings plan and set aside enough each month to have the money you need by the time you’re ready to make the purchase. While that will likely get pretty tedious during the time you’re saving, being able to plunk down cash for something you thought you’d never be able to afford can more than make up for the hassle.