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Financial Literacy 101: Save by paying yourself first

Second in a series for
Financial Literacy Month

April is National Financial Literacy Month — and at SMI we're doing our part with a series of posts on basic principles of investing and personal finance. (Each post in the series can be identified by the orange character at right, diligently working on his financial plan.)

Here's post two, offering practical ideas for building up your savings.

When it comes to saving, despite your best intentions, it's easy to rationalize putting it off until the next paycheck. One way to overcome this is to have some of your money put aside automatically before you have the opportunity to spend it. Here are two paths to automated savings:

• Sign up to have part of your paycheck (you decide how much) automatically deposited into a savings account at a credit union or local bank. It's easy, convenient, and offers useful discipline. Plus, your savings are insured and available for withdrawal without penalty whenever you wish.
• For a higher rate of return, set up automatic transfers from your checking account to a money-market fund (a type of mutual fund) or a money-market account (a type of bank savings account). Such transfers are relatively easy to set up, and you can have them made on a weekly, bi-weekly, or monthly basis.

If you're in your 20s, we suggest saving 5%–10% of your income. Initially, this will go toward building your contingency fund. Once that's in place, your savings can be used for a down payment on a house and other large purchases.

In your 30s and 40s, move up to a savings rate of 10%–15% of your income. Usually at this age, the primary use of savings will be to invest for retirement.

Many people believe they could never save 10% of their income! But let me ask you — what would happen if a cutback at work resulted in fewer hours and a 10% reduction in your income? Wouldn't you make the necessary adjustments in your spending so you could still cover the basics? Unpleasant though it might be, you would.

In the same way, saving a similar amount isn't beyond the financial capabilities of most families. Usually, it's a matter of having the willingness to sacrifice and make the necessary changes in lifestyle.

Adapted from chapter 5 ("Do You Have Adequate Savings?") of The Sound Mind Investing Handbook (5th ed.) by Austin Pryor. Copyright © 2008 by Austin Pryor.

SMI's Financial Literacy 101 series

• Creating your own personal financial plan
• Save by paying yourself first
• Where to put your savings
• How much should you save for emergencies?
• The upside of index funds
• A simple and steady investing strategy
• Inside-out investing
• Making the 'right' investing decisions
• Your most important investing decision

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