Now that you have some discretionary income to set aside and you know you need to be saving money, you may not know exactly where to put it. Deciding where to save your money will depend on the related goal for the use of the funds.
Just like when deciding how much to save, you need to first prioritize your financial goals to determine where to save. Imagine you have three buckets. The first bucket is designated for short-term goals such as purchasing a new car or maybe some furnishings for your home. Short-term goals are goals that you want to accomplish in a year or less. These savings should be invested in a low risk vehicle such as a savings or money market account at a bank. As you prioritize, your primary goal should be to establish an emergency savings if you have not done so already.
The second bucket is designated for mid-term goals. Maybe you want to take an expensive trip or purchase a new home. The time frame for mid-term goals would be 2 to 5 years. For mid-term savings goals, you can be a little more aggressive and invest in savings vehicles such as CDs. For example you can invest in a 3 year CD and lock in interest for that time period. The longer it is to maturity, the higher interest you may receive. This is a good way to get a little more bang for your buck without risking your principle.
Lastly, the third bucket is designated for long-term goals, these are goals with a time horizon that is greater than 5 years. Examples include saving for your children’s education or retirement. Because these events may be further down the road, you can afford to take on more risk than you would with short-term or mid-term goals. For education you should consider tax advantaged education savings accounts such as a 529 savings plan. For retirement savings you should consider tax deferred vehicles such as a 401K or IRA account. Keep in mind that although education and retirement are typically long-term goals if you plan early on, these can be shorter term goals if you had a delay in starting your savings plan. In that case, you want to make sure you put funds in the right savings bucket so that you can invest accordingly.
In addition to tax advantaged accounts, taxable brokerage accounts can be used to accumulate savings for other mid to long-term goals. With brokerage accounts, you will have the opportunity to invest in the stock and bond market as well as cash equivalents. Although this can increase your potential for gain, it can also increase your exposure to risk. I would not recommend the stock market for short-term investing unless you love risk and have the stomach for a wild roller coaster ride.
As with anything, you must have a plan before you can execute it. Once you know why you are saving and have a time frame for that goal, then you will be able to make an informed decision as to where to put your money.
