Saving and investing are often used interchangeably, but they actually mean very different things. Saving and investing are both extremely important. Once a dollar is earned, it can either be spent, allocated to savings, or put directly into investing.

This post is intended to assist those without a background in finance to begin building wealth. We will cover:

• The basics of saving—why, how, and where to begin (part 1)
• The basics of investing—why, how, and where to get started (part 2)
• Types of savings accounts you should explore (part 1)
• Types of investment accounts you should consider (part 2)
• Investing techniques and methodologies (part 2)

 

What is Saving?

Macro-Economic definition:

Disposable Income – Consumption = Savings

Gregory Mankiw

 

AlphaInvestors definition:

Saving is the intentional accumulation of money with little or no risk of loss; it is available quickly and easily (liquid) for explicit purposes such as an emergency expense, a vacation, car, college, house, retirement, etc.

 

Saving

The time to save for the future is now. Thanks to compounding interest, the earlier you start putting money away for the future, the more you will save.  Alexa Von Tobel

Savers have many options to assist them with their goals. Two fundamental questions a saver must ask themselves are:

1. What am I saving for?
2. When will I need the money?

It is essential to realize that many of your expenses will occur over vastly different time frames. The intended purpose (what) and the timeframe (when) will determine which types of accounts are preferable and which types saving plans will optimize your returns, safety, and liquidity. AlphaInvestors can help you plan for your expected as well as unexpected expenses (see Figure 1).

 

Alpha Investors Guide to Saving

You likely have multiple goals that you are working towards, so you will need different strategies and time frames to achieve them. Does getting started seem overwhelming? AlphaInvestors has developed a plan to help prioritize your goals and make saving manageable. The AlphaInvestors’ plan was derived from a plan put together by Charles Schwab.

 

Start by establishing your savings and checking accounts. Next, find a credit card with low-interest rates. If your company offers one, enroll in your employer-sponsored retirement and savings plans. Then begin reducing any outstanding debt you may have accumulated. As your saving grows, you can add goals as they become necessary and as your income increases.

1. Establish your bank accounts.
   1. Open a savings account. You will need a secure place to keep your designated savings and excess cash. Everyone will encounter unexpected expenses from time to time, so your first priority should be to set aside some cash in your savings account for an emergency. Set aside enough cash to cover an overdraft, a car repair, replace an appliance, attend a funeral, etc. In the medium- to long-term, you should strive to save enough for three to six months of living expenses should you happen to lose your job. Benefit: Prevents charges to high-interest rate credit cards that cost more than your investment itself; prevents needless overdraft fees.
   2. Open a checking account. A checking account is specifically designed to receive deposits and pay regular expenses. The proliferation of online bill payments, electronic transfer systems, mobile payments, and debit cards may result in writing few if any paper checks, but a checking account is still essential for your financial foundation. Benefit: A checking account will serve as the central hub of your financial network. You should have your paychecks directly deposited into your checking account.
2. Obtain a low-interest credit card. Most of your purchases will be paid for with a credit or debit card whether they are made online, on a mobile device, or at a local merchant. A credit card is an extremely useful tool to pay for large purchases, regardless of whether they are expected or unexpected. Benefit: A credit card allows you to make a purchase for more money than you may currently have in your accounts. ALWAYS try to pay your bill in full each month to avoid carrying a balance and paying interest or fees. If your emergency fund is not large enough to cover your purchase, use a credit card with the lowest interest rate you can get.
3. Enroll in your employer-sponsored tax-advantaged savings plans. The tax code currently allows employers to offer several types of accounts that are specifically designed to assist their employees with various types of savings and expenses. Use them to your maximum benefit!
   1. Enroll in your employer-sponsored retirement plan. Many employers match their employee contributions at a specific ratio (for example, $.50 for every $1 contributed) up to a specified amount. Benefit: The company match is akin to “free” money. Employee contributions typically reduce your income tax bases, while the interest, dividends, and capital gains accrue tax-free.
   2. Enroll in your employer-sponsored Flexible Spending Accounts. Many employers offer tax-deferred spending accounts that allow employees to save for annual expenses such as healthcare, dependent child care, or even transportation expenses. Benefit: Save money that you would spend normally throughout a year and reduce your income tax bases.
4. Reduce outstanding debt
   1. Pay off high-interest rate credit cards. Many credit cards charge higher interest rates than investments typically earn. Therefore, the longer you carry a balance, the further behind you get. If you carry a monthly balance on one or more credit cards, look into transferring your balances if you are able to pay them off in less than one year, or look into debt consolidation if you think it will take more than one year. Many credit cards charge higher annual interest rates on balances than the stock market has returned annually since the Great Depression. Benefit: Use the money spent on credit card interest for your own savings, investments, or life’s pleasures.
   2. Pay down highest interest-rate debt. Many financial planners suggest eliminating all debt except for a mortgage at today’s extraordinarily low-interest rates. Benefit: Eliminating debt—even if it’s a tax-deductible home equity line of credit or student loans—increases your ability to save. Many financial planners believe that annual investment returns over the next 30 years will exceed current mortgage rates.
5. Open an individual tax-deferred retirement plan. Consider opening a pre-tax individual IRA or a post-tax Roth IRA if your income does not exceed the imposed limits. Advantages: Contributions to an IRA can reduce your income tax basis while the interest, dividends, and capital gains accrue tax-free. A post-tax Roth IRA also allows interest, dividends, and capital gains to accrue tax-free and withdrawals from a Roth IRA in retirement are also tax-free.
6. Begin saving for a down payment to purchase a home. Unless you plan to move or relocate often, begin saving for a down payment to purchase a home. Benefit: Everyone incurs living expenses, so you might as well capture the capital appreciation of the home while you live there. Additionally, mortgage interest may help taxpayers itemize their returns and capture additional deductions.
7. Save for a child’s college education. There are several tax-deferred accounts designed to save for a child’s college education. If college education is in your child’s future, open a tax-advantaged college savings plan. The sooner you begin, the more years of compound growth you will gain. Benefit: Interest, dividends, and capital gains accrue tax-free, and withdrawals can also be tax-free when used for qualified education expenses. Anyone, including friends and relatives, can also contribute.
8. Keep saving and investing. Inflation will always exceed the rates paid on checking and savings accounts, which means that you will be losing money over the long-term. To keep ahead of inflation, savings must be invested in securities that return more than the rate of inflation. Benefit: Developing good habits of spending less than you earn, saving for planned and unplanned events, and investing your savings will help you secure your future and achieve your goals.

How I Finally Built an Emergency Savings

Every marathon begins with a first step, followed by many more. While some may start sooner than others, we can all improve our situation by understanding our finances and making intelligent decisions. All it takes is determination and perseverance, just like a marathon. Check out this inspiring story: How I Finally Built an Emergency Savings

Banking

The first step to financial independence is establishing a savings account and a checking account. Converting a paycheck into cash for purchases can become a significant inconvenience if you don’t have a saving or checking account. Additionally, you will be faced with the perils of carrying all your cash with little or no protection. Opening a savings account can also be a great first step to introducing a child to the financial system so that they can start learning about the benefits of saving. Whether you choose an online bank, a local bank, or a credit union, your selection criteria should be based on:

1. 1. Convenience of access
      • Local branches to process various financial transactions
      • ATMs to access cash
      • Online banking: balance inquiries, transaction history, transfers, bill payment
      • Mobile banking: balance inquiries, transaction history, transfers, bill payment
      • No check writing fees
      • No transfer fees
   2. Minimal fees for services
      • Monthly account fees – waived with a minimum balance?
      • Free online bill payment
      • Free debit card
      • Free ATM usage
      • No check writing fees
      • No transfer fees
   3. Maximum interest earned on your balances
      • Interest earned on checking account balances
      • Interest earned on savings account balances
      • Certificate of Deposit (CD) interest rates
   4. Security of deposits
      • FDIC
      • NCUA

Banks and credit unions cater to different clientele, so take your time and do a little research to find the best solution(s) for your situation! Here is a guideline to assist you: 8 questions to ask before opening a bank account.

 

Checking accounts

A checking account will serve as the central hub of your financial network. If possible, you should always have your paychecks directly deposited into your checking account. Be sure to inquire about overdraft protection or have a savings account designated to cover any overdrafts, otherwise, you may incur additional bank fees. Occasionally you may need to have a certified check printed for large purchases such as a car or closing on a house or condominium, and having a checking account is a must in these situations.

Savings accounts

A savings account is where to keep your savings secure and accessible. Some of your emergency savings, as well as any cash you may need access to within the next twelve months, should be held in a savings account earning interest while it’s there. Online and mobile banking typically allows access to your savings 24/7.

 

Certificate of Deposit (CD)

CDs are financial products that allow you to receive a higher interest rate than a savings account while limiting your access to the cash. As such, they are ideal for medium-term savings, but not ideal if you need the cash quickly. For example, if you have saved to purchase a car but want to wait a year or more for the next model to come out, a CD would likely earn more interest than a savings account with the same funds. On the other hand, you would NOT want to keep all of your emergency savings in a CD. Many banks charge fees in addition to the loss of interest earned for withdrawing your money before the term of the CD expires.

 

Building Your Personal Financial Network

Acquiring accounts and linking them together creates a personal financial network. Your financial network is likely to become more complex throughout your life. You are not limited to the number of accounts you can have, so at some point, you may want to add additional savings and checking accounts as well as shared accounts with a spouse or an elder parent. Your accounts will form a financial network with the checking account as the central hub. Adding a brokerage account to your financial network is one way to facilitate investing. Changing employers may also add additional retirement accounts that can remain independent or be transferred (i.e., rolled over) to your brokerage account as rollover IRAs. AlphaInvestors exists to help individuals build wealth over the long-term investing with Exchange Traded Funds (ETFs).

 

 

AlphaInvestors utilizes proprietary algorithms and statistical analyses to provide individual investors with advice on ETF selection, as well as when to buy and sell them to achieve maximum alpha.  Algorithmic investing (also known as quantitative trading) utilizes computer algorithms instead of active managers for security selection and implementing buys/sells.

Useful Resources:

• Security and Exchange Commission guide to savings and investing
• FDIC bank account insurance
• NCUA credit union account insurance