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Should We Know This?

Information about savings and investing is something I wish I had learned back in high school in order to have a stronger financial foundation. 

If you’re like most people, your formal education did not fully educate on the realm of financial literacy (managing money, creating a budget, investing, preparing your taxes, etc). 

Yet the significance it plays in our daily lives is crucial to our overall well-being. It bothers me that the topic of financial literacy is not a requirement to graduate from ALL high schools nationwide. 

Even Charles Schwab, one of the most successful entrepreneurs and leaders in American business, came out in an article recently sharing similar views.

He states there is a huge lack of financial literacy that our youth are exposed to and how there needs to be a dramatic change in our educational system to make up for this gap.

Learned Habits

I don’t know about you, but I learned most of my understanding of financial literacy from my parents and their habits of spending or saving. 

I grew up in a household that struggled to manage their money. Making purchases they couldn’t afford. Being in debt up to their eyeballs. Eating beans and weenies to get by month to month.

 And at one point, we lived out of an RV campground for months at a time. This may seem a bit extreme, but it’s the reality of some of us.

As my parents began to make more money, they also began to spend more money. The same habits they had before just got worse. 

As I got older and started to make my own money, I too began to realize that I had the same spending habits as my parents.

I bought a brand new vehicle when I got my first job, built a giant house in a gated community, vacationed at Disney World on the deluxe dining plan for two weeks every summer (Those of you Disney World fanatics know how expensive that package is lol). 

Savings and Investing Pinterest Pin image

Maxed Out

It wasn’t until I was up to my eyeballs in consumer debt, paying the minimum amount, living paycheck to paycheck that I realized that my spending habits were out of control! 

This is usually the point at which most people who struggle financially begin to look for solutions.

If you’re at this point in your life, I know your stress. There’s a light at the end of the tunnel and it gets brighter each step along the way. Trust me!

As I’m drowning in debt, I realized that the problem and the solution of this mess I created was looking back at me in the mirror. 

I allowed myself to get this way because of habits that I adopted and from my lack of understanding. I cannot continue to blame others for this now that I’m an adult. I knew there was a wealth of knowledge out there and that I needed to educate myself if I wanted a better life. 

Time For A Financial Change

So I decided that I needed to make a change. That change began in the form of self-education on financial literacy. Understanding where my money was going was the first step. 

This meant figuring out my monthly income and expenses and creating a budget (If you haven’t done this yet or never made a budget before, check out this how-to article to get started).

I’ve become so passionate about educating myself in personal finance that I wanted to share why it’s important to you. 

Getting Rid of Debt

After the budget got established, then came the reduction of consumer debts. I would attribute much of my financial rebalancing to the debt snowball method for paying off debts quicker. 

Once I got free of most of my debts, I reached a point financially where I could put money into savings and investing. 

This was a great feeling except that I knew I was behind on savings and investment. I missed like ten years due to blissful ignorance and needed to make up for it.

And the only way to make up for the years missed out is to have high growth in the money I was getting ready to save and invest.

What I’ll be going over in the remainder of this article is the surface knowledge of some various savings and investing options out there and what it looks like theoretically using a numeric example. This information should help you get started on your journey to financial freedom!

Jar of Coins. Savings and Investing

Ways to Save More Money

One of the quickest ways to save more money is to ensure you have a well-established budget. 

A budget allows you to know exactly the amount of income coming in, where your money is being spent each month, and the progress towards paying off your debts (liabilities). 

It can also help you to identify wasteful spending, which could then be redirected into savings or investments. I would recommend you try doing a No Spend Challenge to get things going in terms of building a savings.

Rule of Thumb: 10%

For savings, the basic rule of thumb that you’ll hear the most is to put away 10% of your paycheck each time you get paid (Richest Man in Babylon mentions this rule).

This is the simplest technique that anyone can accomplish. Heck, you can have this automatically done with online banking.

What Are You Saving For?

A new car? A down payment on a house? A vacation? What about retirement?

Setting your goals will allow you to allocate the saved money accordingly.

If you’re someone who likes to be prepared for the unexpected, then have you created an emergency fund?

Most experts suggest putting aside 3-6 months worth of money to cover your expenses. People tend to overlook the emergency fund because they think they will never be that person to need it.

Unfortunately, there are many people who get into a financial crisis because they essentially had no money aside to provide for themselves or their family during a time of hardship. 

Now let’s say there is a vacation you’ve always wanted to take. You’ve done the research, you know the costs. 

Having that proposed dollar amount allows you to know what you’re working towards and roughly how long it will take to get there.

Retirement 

If you’re focused on trying to build up a retirement nest egg, you’ll need to determine what that amount will possibly be for you.

Now this will be different for almost everyone and there really isn’t a number for you to follow. 

For me, I want to live comfortably in retirement, so my income from my nest egg will need to cover my expenses and be able to keep up with the rate of inflation (average 3%).

Living Off Interest Earned, Not Principal

And by income, I am talking about the interest amount I receive from my nest egg savings and investments, not pulling money (or principal amount) out of those accounts.

Principal Amount in a Nutshell

The principal amount is the original amount of money before interest is applied. If you put $100,000 into your savings account, that $100,000 is your principal amount. The same concept applies to consumer debt. If you spent $5,000 on a credit card, the principal amount is that $5,000. 

One of the main reasons you want to avoid living off of the principal amount that you have saved is because there is no guarantee on how many years that money will need to be used to live in retirement. This is why it is highly recommended to live off the interest that your savings and investments make.

So now let’s take a look at the various savings and investment methods and the typical interest returns they have. 

Leaving Money in your Savings Accounts

The current national averages for savings account interest rates are 0.09%. 

We will use a couple of example numbers to simulate the rate of return for each of the various savings and investment to show you what yearly returns might look. 

  • For $100,000 placed into a savings account with the current interest rates, you will accumulate $90/year.
  • For $1,000,000 placed in a savings account with the current interest rates, you will accumulate $900/year.
  • To make $50,000/year in accumulated yearly interest, you would need $55,555,555.60 in the savings account.

If you are unable to save millions of dollars to live off of the interest that would be produced in a savings account, then this may mean that you’ll have to continue working once you reach the age you thought you were going to retire and/or you should look into investments that have a higher interest rate. 

Placing Money into Certificate of Deposits (CDs)

Another way to grow your money at a higher rate than an average savings account is to look into a certificate of deposit, or CD. 

Most major banks offer customers an option to place their money into this federally insured investment vehicle that has a fixed interest rate and fixed date of withdrawal, known as the maturity date. 

Share certificates, which are the credit union version of CDs, are also low risk, as they’re insured up to the same amount through the National Credit Union Administration. 

The longer the term is on a CD, the higher interest rate you can get on your monies. And you should be able to find rates that are twice as good just by searching for them online or at your local banking institution. 

The current national averages for a 12-month certificate of deposit is 0.64%. 

  • For $100,000 placed into a 12-month certificate of deposit with the current interest rates, you will accumulate $640/year.
  • For $1,000,000 placed in a 12-month certificate of deposit with the current interest rates, you will accumulate $6,400/year.
  • To make $50,000/year in accumulated yearly interest, you would need $7,812,500.00 in a certificate of deposit at this current rate.

Using the current rate for my local credit union (1.7%) on a 12-month certificate of deposit, here is the difference:

  • For $100,000 placed into a 12-month certificate of deposit with the current interest rates, you will accumulate $1,700 at the maturity date. This is over $1,000 more at the maturity date as compared to the national average!
  • For $1,000,000 placed in a 12-month certificate of deposit with the current interest rates, you will accumulate $17,000 at the maturity date. This is over $10,000 more at the maturity date as compared to the national average!
  • To make $50,000/year in accumulated yearly interest, you would need $2,941,176.47 in a certificate of deposit at this current rate. This is less than half the amount you would need for a certificate of deposit that had current national averages!
Stock Market graph for savings and investing

Investing in the Stock Market

To get a potentially higher return on your money than a savings accounts or certificate of deposits can offer, you might want to explore the realm of investing in the stock market and/or real estate. 

In the stock market, there are many facets when it comes to investing, including individual company stocks, mutual funds, ETFs, index funds, and more. This information is just surface knowledge. There are even more complex ways to trade in the stock market, but we will not discuss that in this article.

Individual Company Stocks

You can own a small piece of a company when you purchase their stock. 

With this purchase, you are in essence buying a portion of the company’s earnings and assets. When they perform well, prices go up. 

However, when they don’t perform well, prices can go down. This is a risk that one has to understand. There are no guarantees in the success of each company you choose to select. 

Some companies may also pay a dividend on their stocks annually, quarterly, etc. This is essentially a portion of the profits paid to the investors. Building up dividend stocks of a quality company is a way to develop your passive income. 

There are some people who live off of the dividends of their stocks! Of course this will take having a large quantity of stock, but it’s achievable.

The average return on the stock market, following the S&P 500 index, is about 10%. Just keep in mind that this is an average of the entire market and not the average of every individual company stock. 

Some companies might have tremendous growth, some companies may have little growth, and then there are companies that fall apart. There is always going to be higher volatility of risk if you buy an individual company stock. The odds of picking a winning stock are tremendously low.

Going with our example, this is what returns would look like if you were getting the market average return of 10%. Again, this is strictly hypothetical.

  • For $100,000 of individual company stock getting the average return, you will accumulate $10,000/year.
  • For $1,000,000 of individual company stock getting the average return, you will accumulate $100,000/year.
  • To make $50,000/year in accumulated yearly growth, you would need $500,000 in an individual company stock getting the average return.

Bonds

Imagine loaning a company money and receiving interest on the amount you loaned them. That’s essentially what a bond is. You become a micro bank that companies borrow money from. 

Bonds do not typically have a larger return on them as compared to stocks, but they are relatively safer as compared to stocks. 

However, the safer the bond (ones that are backed by the “full faith and credit” of the United States), the lower the returns or interest rate will be. The riskier the bond market, the more potential for higher returns.

The way a bond typically works is you purchase it at face value and you’re expected to get a set return each year until the bond matures. 

Once the bond matures, let’s say it was a 5 year bond, you will get your original face value back. The average return on bonds is 4.62%.

Going with our example, this is what returns would look like if you were getting the average return of 4.62%. Again, this is strictly hypothetical.

  • For $100,000 face value bond getting the average return, you will accumulate $4,620/year.
  • For $1,000,000 face value bond getting the average return, you will accumulate $46,200/year.
  • To make $50,000/year, you would need a $1,082,251.08 face value bond getting the average return.

Mutual Funds

A mutual fund is like an assortment of candies in a bag. Instead of just one brand of candy, there are multiple brands mixed in. 

When you purchase a mutual fund, your essentially purchasing a portfolio of investments selected by the mutual fund company that will typically be managed by a professional. This portfolio of investments might include stocks, bonds or other assets.

The thing to consider with mutual funds is the expense ratio that you’ll pay on them. The higher the expense ratio is, the more it will cut into the long-term earning potential. 

That expense ratio is essentially what pays the salary of the people who manage the mutual fund for you as well as giving that company a profit too. 

Just like individual stocks, as the prices increase, so does your profit. And also vise versa. The average return on mutual funds over the past 30 years is 3.66%. 

There are mutual funds out there that have done really well, but there are also some mutual funds that have not done so well.

Going with our example and using the average return on mutual funds of 3.66%:

  • For $100,000 in a mutual fund getting an average return, you will accumulate $3,660/year.
  • For $1,000,000 in a mutual fund getting an average return, you will accumulate $36,600/year.
  • To make $50,000/year from the returns, you would need to have $1,366,120.22 in mutual fund getting the average return.

Index Funds

An index fund passively tracks indexes, like the S&P 500, and typically has a significantly lower expense ratio as compared to mutual funds. These funds are also typically less expensive to purchase. 

The index funds are designed to mirror the performance of a selected index by holding shares of companies within that index, but not all of them.

The average return on an S&P 500 index fund is 7.96%.

Going with our example and using the average return on mutual funds of 3.66%:

  • For $100,000 in a mutual fund getting an average return, you will accumulate $3,660/year.
  • For $1,000,000 in a mutual fund getting an average return, you will accumulate $36,600/year.
  • To make $50,000/year from the returns, you would need to have $1,366,120.22 in mutual fund getting the average return.

No matter what vehicle you choose, there will always be a perceived amount of risk involved. You will have to decide what will work best for you in the end because you will have to live with the results of your own decisions.

To get access to some of these different investments, you will have to sign up for an investment account that offers some, if not all, of what you’ve read here. 

Types of Brokerage Accounts

The main accounts that most people will deal with or hear about are 401k, 403b, IRA, Roth IRA, and just a regular investment account.

401k and 403b

Some employers, not all, may offer a retirement investment vehicle for their employees. If you have a 401k or 403b, which is a retirement investment plan sponsored by an employer, then you should check to see what the performance has been like and make adjustments if needed or possible. 

Some accounts may not allow you control over the performance of an account, others might. You will need to find out more details on your own. The yearly contribution limit for 401k and 403b is $19,000. 

IRA or Roth IRA

If your employer doesn’t sponsor a 401k or 403b, then you have the option to open your own Individual Retirement Account or IRA. An IRA is typically provided by many financial institutions and provides tax advantages for retirement savings. 

Each one has a yearly contribution limit of $6,000 or $7,000 if you’re 50 years or older (2019).

A traditional IRA is a tax-deferred account, which means that the money you contributed will not be taxed until you begin to withdraw it later down the road. The money for this type of IRA comes out of your paycheck before your salary is taxed by Uncle Sam. 

This option is good if the tax rate in the future happens to be lower than it is right now.

A Roth IRA, on the other hand, is funded by post taxed dollars, meaning the money left over from your paycheck after Uncle Sam took his share. Since the taxing of the dollar occurs at the beginning, there will be no taxes on the money when you get ready to withdraw it. 

If you already have one of the previously mentioned accounts and you’re wanting to invest more than what you’re allowed to in the other accounts, then you can still have a traditional investment account. 

There will not be any tax advantages when you go this route since you’re using money that has already been taxed in an account that will be taxed when you sell off shares of investments.

Final Thoughts

There are other realms of investments not mentioned in this article that you can learn about elsewhere. The main purpose of this article was to look at the numbers, hypothetically, as it would relate to a certain amount of money invested so you could see what a difference fractions of a percent can make long term as it relates to the money you worked so hard to accumulate. 

The more informed you become about one of these options of managing your money, the more likely you are to actually take advantage of the many benefits. 

Too much time gets spent hesitating in fear of what could happen or wondering what could have happened if you just made that decision. Learn more until you feel confident and then ACT upon it!

Love Every Aspect does not provide tax, investment, or financial services and advice. The information is being presented without consideration of the investment objectives, risk tolerance or financial circumstances of any specific investor and might not be suitable for all investors. Past performance is not indicative of future results. Investing involves risk including the possible loss of principal.

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