Smart Saving Choices

There are easy ways to make your money grow. Here's how to build a substantial nest egg for the future.

Saving money is a simple concept. All you need to do is spend less than you earn and put the difference into an interest-bearing account. Yet many Americans, even those with healthy incomes, have no savings at all.

A solid financial plan should include retirement savings, a rainy day fund and an account that you can dip into for such extras as holiday shopping or an annual vacation. Fortunately, there are now more savings options than ever before. Here are some easy tips to help you make smart savings choices.

Start saving and watch your money grow
Successful saving doesn't have to involve setting aside huge amounts of money; even small amounts will grow large if given enough time. When you invest your money, you not only earn interest on your deposits, you also earn interest on the interest. This is called compounding, and over long periods it can pay huge returns.

As an example, imagine that you deposit $5,000 in an account that pays 5 percent interest. In the first year, you would earn $250. In the second year, because your balance is now $5,250, you would earn $263 in interest. That's a small difference, but over time it would increase substantially. By year 25, you'd earn over $800 in interest and your $5,000 will have become almost $17,000 -- more than triple your initial deposit.

No pain, big gain
In the example above, we imagined that you had $5,000 to deposit all at once. Of course, most people don't have that kind of cash handy; instead, they tuck a little away every month. This is an excellent way to save, as long as you do so as soon as you get your paycheck. Some people try to save by waiting to see how much they have left over at the end of the month. But the truth is that most of us will spend any extra money we earn if we don't lock it away as soon as we receive it.

A good idea is to set up an automatic transfer from your checking account to a savings account once or twice a month, or however often you get paid. By "paying yourself first," you'll never be tempted to spend instead of save, and chances are you won't even miss the money. Web-based high-yield savings accounts make these automatic contributions easy to set up.

Then sit back and watch compound interest work its magic. If you contribute just $100 from each biweekly paycheck to a savings account that pays 5 percent interest, it will grow to more than $5,200 in two years. In 10 years, your simple savings plan will have built you a nest egg of almost $34,000.

The many ways to save
One of the most important parts of a financial plan is putting aside money for retirement. There are several products available to help you reach these goals:

  • 401(k). Many companies offer their employees 401(k) plans, which allow you to save with contributions taken right out of your paycheck. Sometimes employers even match your contributions, in whole or in part. And the amount you contribute is made before taxes are withheld so you pay less tax as well. IRA. If your company does not offer a 401(k) plan, you may consider setting up an Individual Retirement Account (IRA), which also comes with tax benefits.
  • Stocks and mutual funds. Because you should ideally not be touching your retirement savings until you're ready to retire, it can be a good idea to save money outside of your 401(k) or IRA. Stocks and mutual funds can be the answer for long-term investing but because of their potential to fluctuate in value, they aren't usually recommended for short-term savings.
  • CDs. A Certificate of Deposit (CD) is an investment with a specified term (typically three months to five years) and a fixed interest rate. When the certificate matures, you can withdraw your money along with the interest. Because CDs are insured by the federal government, they carry virtually no risk, but you will generally pay a penalty if you withdraw the money before the term is up. Some people get around this restriction by "laddering" their investments -- that is, they buy several CDs six months or a year apart so they do not all mature at the same time.
  • Savings account. One of the easiest and most flexible options is a savings account. Rates on some bank savings accounts can still be less than 1 percent, which isn't even enough to keep up with inflation. But newer saving options, including Web-based high-yield savings accounts, can carry rates that are comparable to CDs. These can easily pay four times more than an everyday savings account at your local bank. Best of all, they often carry no fees, require no minimum balance, and allow you to withdraw money whenever you need it.

Rather than visiting a bank branch and making deposits with a teller or an ATM, you link a high-yield savings account to your everyday checking account and transfer money electronically. In most cases, you won't be able to access your money with an ATM card or by writing checks. But the trade-off is that online accounts cost less to administer, so financial institutions can offer you higher rates and no fees.

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