What Are Savings?
In personal finance, savings refers to the portion of income that isn’t spent on immediate expenses and is set aside for future use.
This money can be kept in various forms such as cash, a savings account, or invested in financial instruments like stocks, bonds, retirement accounts, and cryptocurrencies. The goal of saving is to preserve and grow wealth over time for future financial goals, emergencies, or retirement.
Why Are Savings Important?
Savings play a crucial role in personal finance, your overall financial well-being and security. It’s an essential habit that helps secure your financial future, provides security against unforeseen circumstances, and promotes financial discipline.
Its importance can be understood in the following ways:
1. Emergency cushion
Savings can provide a financial safety net in the event of unexpected expenses such as medical emergencies or sudden loss of income. Having this cushion allows you to cover costs without resorting to high-interest debt options like credit cards or loans.
2. Financial independence
Regular saving can lead to financial independence over time. It provides the freedom to make significant life decisions such as changing careers, going back to school, or even retiring early without financial stress. You can also reach your personal financial goals, whether it’s buying a home, starting a business, funding a child’s education, or planning a dream vacation.
3. Retirement planning
Regular income may cease during retirement, so it is important for individuals to accumulate sufficient savings to maintain a comfortable lifestyle. The earlier you start saving for retirement, the more time your money has to grow.
4. Encourages discipline
The practice of regular saving encourages financial discipline and money management skills. It prompts budgeting and prioritizing essential expenses, thereby promoting healthy financial habits.
Effective Strategies for Growing Your Savings
Savings strategies refer to the plans and techniques that help individuals set aside a part of their income for future use.
Here are some popular savings strategies:
1. Creating a budget
A budget provides a clear view of your income and expenses. It helps you identify where your money is going, and where you can cut back. The money saved from cutting back on non-essential expenses can then be directed toward savings.
You can begin this process by tracking every dollar you earn, and spend, for a few months. Understand your “needs” like rent, utilities, and groceries versus “wants” like eating out and entertainment. A spreadsheet is sufficient, but there are many apps that can link your bank account and categories spending automatically for you.
Consider the 50/30/20 rule as a baseline for budgeting: 50% of your income goes towards needs, 30% towards wants, and 20% towards savings. Of course, you can adjust this ratio by allocating less toward wants and more towards saving to grow your savings faster.
2. Setting specific financial goals
Your saving goals should be SMART: Specific, Measurable, Achievable, Relevant, and Time-bound. For example, instead of saying, “I want to save for a house,” you should plan for something like “I want to save $50,000 for a down payment on a house in five years.”
Divide your goals into short-term (less than a year), mid-term (1-5 years), and long-term (more than five years) categories. This division can help you identify how much you need to save and how to best save or invest for each goal.
3. Building an emergency fund
Before you start saving for other goals, prioritize creating an emergency fund. The common advice is to save 3 to 6 months of living expenses, but the right amount depends on your personal circumstances. If you have an unstable income or dependents, you might want to save more.
Keep this fund in a liquid and easily accessible form, like a regular savings account, even though the returns are low. The primary purpose of this fund is not growth but accessibility in case of an emergency.
4. Automatic savings
The easiest way to save is to make it automatic. You can set up automatic transfers to your savings account on your payday. There are apps that round up your purchases to the nearest dollar and automatically deposit the difference into a savings account, and many investment platforms allow you to set up automatic contributions.
5. Increasing your income and lowering your expenses
You can enhance your savings potential by reducing expenses, such as curtailing discretionary spending and minimizing non-essential, recurring costs. Alternatively, consider increasing your income. This might involve initiating a side hustle or establishing multiple streams of passive income.
How Does Inflation Impact Your Savings?
Inflation erodes the purchasing power of money over time, meaning your saved dollars today might not buy as much in the future. This is particularly true when inflation is high. Here are some things to consider for your savings during times of high inflation:
1. Pay attention to the real rate of return
The real rate of return is the rate of return on your investments after adjusting for inflation. For instance, if your savings account provides a 2% return but inflation is 3%, you’re actually losing purchasing power. Look for investments that can provide a higher real rate of return.
2. Consider inflation-protected assets
Consider investing in financial instruments that offer protection against inflation. In the US, for example, Treasury Inflation-Protected Securities (TIPS) are government bonds that adjust with inflation, ensuring that your investment keeps pace with the cost of living.
3. Diversify your savings portfolio
You can diversify your savings portfolio to lower overall volatility and provide better stability. Over the long term, some assets such as real estate, stocks, gold and Bitcoin have traditionally been a good hedge against inflation.
4. Increase the yield of your savings
You can consider putting your savings into assets that can offer a high yield that offset inflation. It could be a high-yield savings account, highly liquid high-quality government debt, and certificates of deposit. If you do lock up your savings for longer (months or years), ensure it doesn’t impact your daily expenses or emergency funding needs.
Remember, everyone’s financial situation is different, so what works best for you will depend on your personal circumstances. If you’re unsure about how to adjust your savings strategy in response to high inflation, it might be a good idea to speak with a financial advisor.
Should You Put Your Savings in Crypto?
Cryptocurrencies can be a part of your savings strategy because they have shown impressive historical performance despite their extreme volatility. The leading coins, bitcoin (BTC) and ethereum (ETH) in particular, have both exhibited spectacular returns since their inception.
If you invested $100 in bitcoin in July 2010, when the price was around $0.06, it would be worth around $50 million as of mid-2023. If you had invested $100 in ether during its initial coin offering (ICO) in 2014 at $0.31 per coin, your portfolio would be worth around $580,644 in total as of mid-2023.
While past performance isn’t indicative of future results, you can consider investing in cryptocurrencies if you can tolerate the risks and volatility. Before starting, take the time to understand what cryptocurrency is, how it works, its potential uses, and the risks involved.
You can then start with a small investment that you’d be comfortable losing. As you gain more experience and knowledge, you can adjust your investment accordingly. Similar to traditional saving methods, you can set up a system where you regularly buy a certain amount of bitcoin or ether, for example.
Of course, as with any investment, don’t put all your money in one type of cryptocurrency. You can diversify your cryptocurrency portfolio by spreading your allocations to various coins.
Lastly, always choose reliable and secure platforms to buy and trade your cryptocurrency. Look for platforms that offer strong security measures, long-term track records, withdrawal whitelists, and good customer support.
Remember, while cryptocurrencies have the potential for high returns, they also come with high risks, including complete loss of investment. Make sure you fully understand these risks before you start investing in cryptocurrencies. Always invest wisely and only invest what you can afford to lose.
Closing Thoughts
Personal savings constitute an essential aspect of your financial well-being. Saving enables you to be prepared for unexpected expenses, accomplish financial goals, and achieve financial independence. The importance of cultivating a consistent saving habit cannot be overstated.
In today’s ever-evolving financial landscape, there are myriad strategies available to help you maximize your savings. Traditional methods, such as creating a budget or setting up automatic transfers to your savings account, remain effective. However, it’s also worth considering more contemporary options like investing in cryptocurrencies as part of a diversified portfolio.
Nonetheless, the best saving strategy is the one that aligns with your financial circumstances and goals. If inflation is high, you may need to take additional steps to protect your savings, such as investing in assets that tend to perform well during inflationary periods.
Remember, every bit you save counts. Even small, regular amounts can accumulate into significant savings over time thanks to the power of compounding. And while it’s crucial to save for future needs, it’s equally important to have an emergency fund for unexpected expenses.
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