Published: February 25, 2009

Make Your Money Work For You (2009)

Saving to Build Wealth

This brochure provides information about the importance of saving, setting short- and long-term goals to promote saving, opening a savings account and ways to make your money grow faster, including certificates of deposit (CDs), individual retirement accounts (IRAs), U.S. Savings Bonds and college savings accounts.

Getting started on saving

Building wealth is like building a brick wall. You place one brick on top of another and make sure the wall is solid before you put on the next brick. Saving to build wealth is similar—you have to set realistic goals and work to accomplish each step before moving on to the next brick, then the next row.

You may think it is hard to save. But if you set aside even small amounts on a regular basis, in just a short time you can build a cushion to help you weather short-term emergencies, such as car repairs or the need for a new household appliance.

Take your time

You can’t build wealth overnight. A good first goal is a savings account for emergencies. An emergency savings account is money you set aside to cover expenses in case you lose your job or suffer an injury that keeps you out of work.

Emergency funds should equal three-to-six months of take home pay for the family’s primary breadwinner. Emergency savings can also be used for unexpected and expensive household expenses, such as car repairs or a furnace replacement.

Interest

Interest is the cost of using money. Your bank pays you interest when you leave your money on deposit. If you borrow money, you pay interest to the lender. Saving institutions often use the letters APY (annual percentage yield) after an interest rate. This is the amount your money would earn if left on deposit for one year. There are two kinds of interest, simple and compound. Simple interest pays interest only on your deposits. Compound interest is better, because it allows you to earn interest not only on your deposits, but also on the interest you earn as time goes on.

Small changes, big savings

Tracking day-to-day spending can help you to avoid wasting money and to develop a budget. A budget is a spending plan that helps you forecast and control your expenses. Knowing what you spend now is the first step in creating a budget.

Many people find that a few small changes can add up to big savings. To create a budget you need to know how much you spend each month—and then compare that figure to your take home pay. Once you have established a budget and lived with it for a few weeks, you’ll see what to cut back on. If you spend less than you earn, you’ll have some money to save.

Scoring a goal

Financial goals are personal markers that you set for yourself throughout life. They often fall into short-term and long-term categories. Knowing your goals can help you save for them. Short-term goals are ones you would like to achieve in one or two years, such as finishing your education or buying a car. Long-term goals may take more time to reach—it might take five years or more to be in the position to buy a home, and much longer to save enough for a secure retirement or pay for your children's college education.

Stashing the cash

It’s better to keep your emergency money in an account where you can withdraw it quickly and easily when you need it. (If you are on public assistance, there may be limits to how much you are allowed to have in your savings. Before you start a savings program, check with your benefits counselor.)

Money that is easily available is said to be “liquid.” You can keep funds that you might need at short notice in a savings account or credit union share account, a money market deposit account or even a short-term certificate of deposit (CD).

In a government-insured savings account, your money won’t earn much interest, but it will be safe and easy to access. Short-term certificates of deposit (CDs) might pay a little more than your savings account does. You can find terms as short as one month on CDs. On the Internet, Bankrate.com can help you compare interest rates at different institutions.

Saving accounts

Savings accounts are designed to keep your money safe and help it grow. Accounts at banks are insured by the federal government for up to $250,000. The bank pays you interest on the money you have in your account. You can make deposits into your account and withdraw money when you need it.

Like banks, credit unions offer savings accounts (called share accounts) and other financial services. Credit unions are nonprofit savings and lending organizations that provide services to members who have a common bond, such as working for the same company, living in the same community or belonging to the same church. Deposits in federal and state chartered credit unions are insured for up to $250,000 through the National Credit Union Administration (NCUA).

Individual development accounts (IDAs) are special sponsored savings accounts that help low-income families save money for qualified post-secondary education or job training, to buy a home or to start their own business. Private and public institutions match contributions. Most IDA participants must take classes to help them repair their credit, create a budget and stick to their savings plan. An online directory of IDA programs nationwide is offered at www.idanetwork.org. Click on “IDA Directory,” then enter your state or ZIP code in the box to find local IDA programs.

Setting up an account

To open a savings account, most banks require two pieces of ID, one with a picture on it. You will usually need a Social Security number to open a bank account. The amount required for an initial deposit varies. Some banks require only $1—others ask for $50, $100 or $500. You may use cash or a check to open an account.

When you open a bank account your banking history may be verified with an account screening company, such as ChexSystems. If you’ve ever had a problem with a bank account, such as closing your account without enough money to cover all outstanding checks, you may be denied a new bank account. To understand why you were denied an account, go to www.chexhelp.com to receive a free copy of your personalized banking history, called a consumer report. If the screening company has incorrect information on file about you, you have a right to prove it’s wrong.

Getting the most from your savings

If you save regularly, the day will come when you can buy wealth-creating assets that increase in value or earn money. Such assets include savings accounts, retirement plans, stocks and bonds and your home or other real estate. In the U.S., the greatest source of wealth for most households is the value of their homes.

Most experts advise that you try to save 10% of your earnings each year. If this is hard to do, start with a smaller percentage. To force yourself to save, schedule automatic pay-day deposits that go to a savings account or individual retirement account (IRA).

Certificates of deposit (CDs), also called time deposit accounts, are a safe way to make your money grow. Most CDs are issued by banks, but you can also buy them through brokerages. CDs sold by banks and some brokerage companies are insured by the Federal Deposit Insurance Corporation (FDIC) up to $250,000 per depositor.

CD rates vary widely, although they are usually higher than rates paid on savings accounts. You leave your money in the CD for a specified period and in return you earn favorable interest rates. In general, the longer you leave your money on deposit, the higher the interest rate you’ll earn. The times vary from one month to 5 years. If you cash out a CD before the maturity period ends, you’ll pay a penalty.

Investing in the U.S. government

Treasury securities are safe and secure investments because they are guaranteed by the U.S. government. Savings bonds can be purchased in denominations ranging from $50 to $10,000. You buy the bonds at a discount from their value at maturity. Interest varies, but you always get a minimum return. Savings bonds are payable only to the person to whom they are registered.

You can buy Series EE (guaranteed to reach face value in 20 years) or Series I (inflation adjusted) bonds. EE bonds are issued at 50% of their face value. (A $100 EE Bond costs $50.) Series I bonds are issued at face value (a $100 I Bond costs $100) and pay an interest rate that is adjusted twice a year for inflation. For more information visit the Savings Bonds web site (www.savingsbonds.gov).

Tax breaks for retirement

Individual retirement accounts (IRAs) are savings accounts designed to help people put away funds for their retirement. For the latest dollar limits on annual IRA contributions visit the Internal Revenue Service website at www.irs.gov. Type “Publication 590” in the Search box to learn more. Federal regulations require that IRAs be managed by a custodian, such as a bank, credit union, insurance company, mutual fund or brokerage firm.

There are two kinds of IRAs, traditional and Roth IRAs. Traditional IRAs give account holders a break on income taxes because you can fund the account with pre-tax income and deduct contributions in the current tax year. You don’t owe income taxes on your contributions or investment earnings until withdrawal, usually after you are 59 and a half. If you withdraw money from your IRA before that time, you must pay a 10% penalty on top of any income tax that is due.

Roth IRAs are not tax-deferred (you invest after-tax income) but earnings are tax-free.

You may contribute to a traditional IRA and a Roth, but the same contribution limits still apply. Go to www.irs.gov for current contribution limits.

If you are over age 59 and a half, or disabled, Roth IRA withdrawals are not subject to federal income tax as long as the account is at least five years old. You may make withdrawals at a younger age if you are using the money for qualified first-time homebuyer expenses or significant out-of-pocket medical expenses. For other exceptions and more information on IRAs, visit (www.irs.gov).

Saving at work

Don’t miss a chance to save at work. Some employees avoid participating in company retirement plans because contributions reduce their take-home pay. But you can maximize your retirement savings by taking advantage your employer’s matching funds. Employer-sponsored plans usually match your contributions up to a certain limit, so if you invest some of your own pre-tax money, you’ll be eligible for your employer’s contributions. At tax time, you will owe less money because the portion of your salary that you contributed is not taxable.

You may be required to self-direct the investments in all or part of your employer-sponsored savings plan. Check regularly with your plan’s investor assistance services to make sure that your account is well diversified. A diversified account contains a variety of investments—not just your employer’s stock.

Risks and rewards

Everyone would like to earn the highest possible return on their money. But as the return goes higher, so does the risk that you might lose your money.

Savings accounts and bank CDs that are insured by the FDIC offer a smaller return than other types of investments because they are safer. In contrast, stocks, bonds and mutual funds are not insured and historically have earned more in the long run.

When you are considering an investment, it’s important to ask about potential returns, risk and liquidity (or how easy it is to get your money when you need it). It is unlikely that you will find a single investment which gives you the best of all three: high return, low risk and ease of access.

It can be risky for individuals to buy stocks. Do not blindly follow anyone’s advice about stocks without checking out the information for yourself. There is no guarantee that stock prices will go up or that you will make money on stocks.

Many individuals invest in mutual funds to “diversify,” or spread out the risk of investing in stocks. Mutual funds are portfolios of stocks, bonds and other securities in which the public can buy shares. Each investor shares in the fund’s gains, losses and expenses. You can lose money in mutual funds, too.

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Make Your Money Work For You (2009)
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Keywords

Moneywise, Moneywi$e, Savings 2009, Wealth, Money, Employer Matching Contribution, Ira, Roth Ira, Buy Stocks, Savings

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Capital One

Notes

This brochure was created by Consumer Action in partnership with Capital One Services, Inc.

Category

Money Management   ♦   Investment   ♦   Banking   ♦  

Copyright

© 2009 Consumer Action. Rights Reserved.