The Ideal Money Breakdown

There are so, so, so many options for what to do with your money. The average American keeps some cash in their savings account and that's about it. Very few of us use our money efficiently. For starters, this is because we feel like we aren't making much, so what's the point of saving a couple thousand dollars a year? If that's all we can afford, we may as well save nothing, right? Money is tight and it's never going to reach $1,000,000, so why bother trying?


Well, hopefully you'll read this post and this post and this post and realize that that mindset is dangerously wrong.



The sooner you start saving, the sooner your money starts growing. This means if you can buy $100 in stocks when you're 18, it might be like putting $700 in the stock market at age 38. That's an easy $600 you didn't have to work for!


Now that I've convinced you successfully to start saving (whether 5% or 50% of your income), you just have to figure out what to do with it. I'm going to break down savings into three sections, and will tell you how much money to put there and how to go about building up that fund. As you know, I'm not a CFP (yet) or anything of the sort, so make sure to do your own research.



CASH.


I consider money that is kept in a savings or checking account to be cash. It is guaranteed by the federal government, earns you basically nothing, and is always there when you need it. It's 0% risk, but 100% guaranteed to lose value every year (inflation).



Common knowledge says you should have 3-6 months of expenses saved up total for an emergency fund. However, I spread my emergency fund over cash and short-term investments (see next section). Cash is always losing value, so don't hoard your money there! I plan to keep about 1-2 month's expenses in my checking account. This money generally should be restocked any time you use it, excepting extenuating circumstances. So if you get paid every 2 weeks, after your paycheck is deposited you should have 6 weeks of expenses in your account.


For me, a month's expenses is about $2,500 but I run cautious so I'll plan to keep $5,000 for unexpected expenses in my regular checking account.


$5k (or even less) might seem like a lot if you're making $1-3k per month. I recommend taking your savings rate and putting half of it into cash until you've reached your desired fund amount. For example, say you make $25,000/year, and you're planning to save 20% of your income -- great! This means saving a total of $5k/year, or $417/month. I recommend putting half of this amount -- $208/month -- into a cash account until you save up a few thousand dollars. This would take 8 months to save up 1 month's expenses or 16 months to save up 2 month's expenses. Not that bad, eh?



SHORT TERM SAVINGS.


Okay, but what about the rest of your emergency fund?? Another 1-4 months worth of expenses should be saved in short-term investments, by which I mean low-risk, medium-gain investments that keep up with inflation so your money doesn't lose value, but where you can access the money at any time.


Here's why stocks aren't good short term investments: Stocks are volatile. You might need the money when it's sitting at half its original value. By pulling it out, you lose the other half. This is actually pretty common because emergency funds are needed the most during economic down-turns and recessions, which is also when the stock market isn't doing well.


Here's why simple bonds aren't good short term investments: Bonds generally require that you make a multi-year commitment. For example, you'll get 5% returns if you loan your city money for 5 years. If you need it early, you won't get the interest you were promised and might actually have to pay a fee. So it's not great to use your bonds in case of emergency.


So what are we to do?!? Why, a money market fund, of course!



Money market funds are genius creations that are basically huge funds made up of bonds, CDs (certificate of deposits), cash, and other reliable investments. Enough people are invested in these funds so that you can pull your money out at any time (with no repercussions). And if you keep your money in, you'll earn a consistent, reasonable amount of money.


So, the dirty details: I plan to save up 4 months of expenses ($10,000 for me) in a money market account (I chose Fidelity's SPAXX account). If that seems like an insane goal, just put in 25% of your savings goal each paycheck. From the previous example, if you are saving 20% of your $25,000 salary, that means putting $104/month into a market fund. It'll take you a few years, but you'll see your emergency fund growing steadily. Plus, once you finish filling your cash fund, you can contribute that 25% here too. Be sure to keep re-filling your emergency fund as you spend it on things like vacations, cars, and actual emergencies. Before you know it, you'll be ready for anything that happens tomorrow and can funnel even more money into your...



LONG TERM SAVINGS.


Yep, this is the big one. Long term savings means saving for retirement mostly, plus a house or car or trips that are still 5+ years away.


This is generally made up of a 401(k) (if your company offers one), an IRA (that you set up yourself), and a brokerage account. The money in a brokerage account does not have tax advantages, so you'll have to pay taxes on any money you make. However, you can take it out at any time to use it without penalty (unlike the 401k and IRA, which I compare in this post).


This is an account where I can't tell you exactly how much money to save. Keep saving until you stop working. The average human wants to have ~$1 million in their retirement accounts before they stop working. Plenty of people retire on a lot less, because they have to (they're unable to keep working) or because they want to (they can live off of the smaller income). On the lower end, I know a few adults in my family retired on under $400,000. However, with that number it's difficult not to dig into your savings over the years.



Generally, you'll want to save up 25x your annual expenses so that you can live off of the interest of your investments. Read more about that here.


Try to put the rest of your savings goal into this one. In fact, try increasing your retirement savings by 1% a month until your wallet gets too tight. I've already showed you this, but every extra dollar now will save hours of work later:





There's no exact science to splitting up your money between IRA, 401k, and brokerage accounts. Talk to a professional for personalized advice. Remember to max out any employer match on your 401k first, then contribute to whatever account you prefer.


Personally, I have a Traditional 401k and a Roth IRA. I plan to max out the Roth IRA every year ($6,000) and max out my employer match on the 401k ($6,000). After that, I'll try to add whatever else I can to my 401k!



May the money gods bless your savings!


How do you store your money? How much emergency $$$ do you keep on hand?




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