On Saving

Saving is a way of putting aside money you have now so that it will be available later. Saving is both a habit to be developed and a way of investing in the future. Even small children can learn how to save - every week when our children got their allowances, in addition to some money they were to use for immediate spending, and some money for charity, they put aside some money to accumulate for a later purchase they might want to make. They had the old-fashioned savings books, and every time a relative gave them money as a gift, at least some portion went into savings. When they had jobs, again a portion went into savings.

To save involves establishing a habit. If possible, saving should be made as automatic as it can - if you have a paycheck, have a portion directly deposited into a separate savings account (which might not be a traditional bank saving account). If you have access to an IRA at work, direct deposit the most you can afford into it. If you have money you receive directly, deposit a specific amount or percentage into savings. "Windfalls" - amounts of money that show up unexpectedly - are great candidates for savings as you weren't expecting to receive them.

But in order to know what to do with your savings, you need to have an idea of why you're saving - your goals. A basic purpose for savings is to smooth expenses - sometimes you know that there is a large expense looming - a capital purchase like an appliance, or moving expenses, or a wedding coming up, tuition, or even paying real estate taxes if you own a house - and your regular monthly income may not be able to absorb such a large expense, so you save for it over a period of months.

Another important purpose of saving is to establish an emergency fund in the event of loss of income. Everyone should have an emergency fund covering monthly expenses for a period of three to six months - it's a good idea to err on the long side.

Then there are intermediate-term savings goals - to pay for a vacation, to accumulate a down payment for a house purchase, to buy a car, to pay for all or part of a tuition expense in a year or two. There are also longer-term savings goals, such as to accumulate money for retirement.

Depending on how close or far the event is for which the money is saved, the money probably should be invested in different ways. Money that will be needed immediately, or in the short term, and the emergency fund, should be held in a safer place where the value is very unlikely to decline, such as an interest-bearing savings account, short-term bank CDs (banks should be FDIC-insured) or a lower-risk money market fund run by an established mutual fund company. The point is not to make much if any money on these "must-have" funds but to insure that they do not fluctuate in value.

Money needed for intermediate-term goals can take a bit more risk - longer-term CDs or U.S. treasuries, or a mutual fund that has a conservative bent but takes slightly more risk, say by including some amount of stocks. The goal here is to be prudent - big losses couldn't be made up in the intermediate term - but to also accrue a somewhat higher level of earnings than the safest investments.

Long-term money, or money that doesn't have to be used at any particular time, where you can avoid taking money out at a point where the value is down and where you'd like to earn a better return, can be invested in more diversified investments, including stocks, bonds and even other classes of investments. In some cases, there may be special tax-advantaged savings vehicles for tuition savings. Mutual funds aren't the most tax-efficient way to invest, but for the small or medium-sized investor, they can be an easy way to get one-stop shopping and get a balanced portfolio of investments. There are also "lifestyle" funds that hold various percentages of different types of investments depending on your age or circumstances. Obviously, however, if your retirement funds need to be available within a shorter period of time, at least a portion should count as short or intermediate-term savings.

So, in summary, establish the habit of savings, plan for sums you need in the future and divide the savings pot into separate categories for investment depending on when and if you need access to the funds.