Let me tell you why you should save and then invest. Saving and investing are not quite the same. Yes, you do put money away and earn interest or dividends. However, when you save money, you want to be able to have it readily available. In other words, it should be a liquid asset. Liquid asset is the financial term for short-term investing. Money invested in stocks, bonds, mutual funds, ETF’s, etc. are used for long-term investing, so that your money will grow. The returns from these investments are higher than the interest you earn from a savings account. However, they carry a higher risk. You could lose part or even all of your investment. Savings held at federally insured institutions offer a low risk and a lower interest rate. Your money is insured by the FDIC up to $250,000.
When you save for your emergency fund, you want it to be easily available. Initially, you want to start by saving $1,000 for emergencies. Then, you want to increase your emergency savings to eight to twelve months of living expenses. You can save your money at a local or national bank, an online bank, a local or national credit union, or in a money market account at a discount brokerage house, like Scottrade, TDAmeritrade, Charles Schwab, etc. Wherever you invest, ensure that it is an FDIC insured financial institution. If you do save your money at a discount broker, don’t use this money for investing. It is to remain untouched until you need it, in case of a job loss, illness, etc. It is what you will pay your living expense from when you don’t have a source of income.
You should also have a separate savings account to cover your expenses that come up either twice a year or once a year. These are items like car or home insurance, property taxes, gifts, Christmas gifts, etc. You should also be saving money to cover your car repairs and car replacements, home repairs, appliances repairs and replacement. Again, you should have easy access to this money and not incur any penalties for withdrawing your money. Let’s call this savings account your home repair/replacement account (HRRA). You can even save money in this account to purchase a home down the road.
Investing on the other hand should be done when you have your emergency fund fully funded and your HRRA in place. You are free to tie-up your investment money for a longer period of time. You want to invest in your retirement account. You should be savings 15% or more of your annual income. If your employer offers a match, then invest there up to the amount of the match.
Sometimes employers offer Roth 401(k) accounts. If your employers does offer these, this is where you should invest your money. You use after tax money to make your contributions into these accounts. The great part is that when you retire, your withdrawals, after age 59 1/2, are tax-free. The withdrawals from a regular 401(k) are taxed as ordinary income. Also, the Roth 401(k) does not have a required minimum distribution (RMD) at age 70 1/2. You can let your money sit there and grow. You can leave your money to your heirs and they too will be able to withdraw this money tax-free. With a regular 401(k) you have to start withdrawing your money at age 70 1/2.