Saving is an important step on the way to financial well-being, both in the short term and in the long term. In the short term, it gives you an emergency cushion in the event that an unforeseen, large and urgent expense arises. In the long term, a consistent pattern of saving can enable you to accomplish your financial goals, such as financing a college education, a home purchase, or a retirement.
If more money comes in every month than goes out, congratulations -- you're saving. If not, head over to the credit and loans section . If you're not sure, take another look at the budgeting section. If you are in debt, you should start saving to pay it down (especially if it's debt at a high interest rate, such as on a credit card). Once you are free of high-interest debt, the next step is to build up a cash cushion to protect you from emergencies, such as a layoff or a medical expense.
How much should you build up and set aside? Experts recommend that you build up at least three to six months' worth of living expenses. The right amount for you will depend on the following:
- What are your financial responsibilities? If you're the head of a household, or have dependents or anyone else who relies on your income, you'll want a larger cushion.
- How willing are you to take risk? If you're risk-averse, you'll want a larger cushion.
- What expenses do you anticipate having in the coming few years? If they're higher than usual, you'll want a larger cushion.
- How regular is your income? If you are self-employed, work on commission, or otherwise have income that fluctuates, you'll want a larger cushion.
Some people feel that they don't need this cash cushion, claiming that they can just run up credit card debt if they need to. While this may be true, taking on credit card debt is a dangerous trap to fall into, because the high interest rates make it difficult to escape from. (If you do decide to rely on credit for emergencies, consider a home equity line of credit, which generally charges a significantly lower interest rate than credit cards do). Additionally, saving the money is a great idea even if you don't need it for an emergency, because then you'll be able to use it toward your long-term financial goals. Others say that they have stock and could just sell it if they needed to. Again, they're correct, but the downside is that circumstances might force them to sell the stock even when they don't want to.
As you build up your emergency fund, and even once you've finished building it, the money should remain in a safe place. Any money beyond this cushion that won't be needed for several years can go toward higher-risk, higher-reward investments such as stocks, but this emergency fund should not be placed at risk. Since you will want to be able to access the money on a moment's notice, keep it in a money market account or money market mutual fund.