Investing for your financial future is imperative, but not everyone is necessarily ready to start saving for then when they need that money for now. While you should certainly start investing as soon as possible so your investments can grow (and survive market volatility), it’s important to have an adequate savings fund to manage emergencies and near-future goals. In other words: Save for the short-term before you start putting dollars away for the long-term.
So, how much money should you save before investing? Financial advisors generally recommend saving anywhere between three months and a year’s net salary before making higher-risk decisions with your money. Of course, where you fall on that range depends largely on your income and lifestyle.
Whether you save three months, six months or 12 months, however, you shouldn’t necessarily lump all of your savings into one account. Categorizing your savings into two separate sub-savings accounts — your emergency stash and your sinking stash — can help you sustain your savings. Only once you have sufficient funds in each of these should you start investing a percentage of your income.
Let’s dive in.
How much money should you save in an emergency fund?
Because your emergency fund exists to cover any unanticipated emergencies, it’s difficult to anticipate just how much money you’ll need in this account. You might lose your job at a moment’s notice and need at least a few month’s rent to pay your bills until you can get back on your feet. Accidents happen, and you could end up with thousands of dollars in repair or medical bills. In fact, the average cost of an emergency room visit is about $1,389. If a loved one passes, the average funeral costs upwards of $12,000. Maybe you drop your smartphone; just fixing the screen can cost you hundreds.
While these catastrophes aren’t pleasant to think about, they’re important to think about. And you need an emergency savings account that can cover these unexpected costs — or else your risk amassing high-interest credit card debt. Most financial advisors recommend that you have at least about six months of your income saved as a cushion should life happen.
Just make sure you put your emergency money in a savings account that will earn you interest. High-yield savings accounts that earn you one percent or more will help your money make more money while you save.
How much money should you save in a sinking fund?
Your sinking fund is the percentage of your income that you put aside to cover the costs of upcoming expenses. Sit down and consider for what exactly it is you need money. Perhaps you’re looking to drop a down payment on a home soon, or you’re finally taking a vacation with that paid time off you’ve been accruing all year. Maybe you’re planning a wedding, or maybe you’re just in need of a new washing machine that’s less noisy. Whatever the case, your sinking fund is the place you’ll save for these wants and needs.
Just how much money you should have in your sinking fund, however, depends on your particular lifestyle. So do the math. Take a look at the costs of what it is that you’re planning to purchase, and start setting aside a small percentage of each paycheck so you can afford it by a designated date.
Generally speaking, however, it’d be wise to have at least $X in your sinking fund to start.
You may decide to further break down your sinking fund into buckets — perhaps a one-to-three-year bucket, a three-to-10-year bucket and a beyond bucket. Then visualize what you presume you’ll need available in each timeframe. If you know, for example, that in the next three years, you’re likely to be a bridesmaid or groomsman in a number of weddings, perhaps you need to budget that into your first bucket. If you know that, in the next five years, you’re planning to buy a place, you’ll want to start thinking about the costs of a down payment and a mortgage.
When should you start investing?
It’s ultimately up to you to decide when you’re comfortable to start investing. There are tons of free savings calculators out there to help you set savings goals, such as Bank Rate’s Simple Savings Calculator and Nerd Wallet’s Savings Calculator. Both of these options allow you to input a starting balance, a monthly contribution amount, the period of saving time and an annual interest rate. Plug in your numbers and see how much you can save in a year or two, for example.
We want to reiterate that you absolutely should save for the short-term before investing for the long-term. That said, you don’t want to delay investing for too long. Having savings for your long-term financial security is just as important.
While investments are riskier than savings, they have far more growth potential. This means that, the sooner you start investing, the more time your money has to make more money. Because many people rely on these funds to live well beyond retirement, it’s vital that you take your financial future seriously.