Building strong financial habits early in your career is essential for long-term security and to ensure that someday you are ready to retire. It can feel overwhelming to begin saving and investing. This article is a resource to help you understand which accounts you should consider using. We will cover emergency funds, employer retirement accounts, brokerage accounts, and Roth Individual Retirement Accounts (IRAs).
Emergency Funds
An emergency fund is crucial to cover potential job loss and unexpected expenses, such as medical bills or car repairs. Consider opening a high-yield savings account (learn more here about high-yield alternatives to holding cash) and aim to set aside three to twelve months’ worth of living expenses (including rent, groceries, and bills). The specific target will depend on personal circumstances, such as job stability, whether you are the sole earner in your household, and your comfort level with risk. Having cash readily available can provide peace of mind.
Consider automating savings to this account by setting a percentage (e.g., 10% or 20%) or a fixed dollar amount of your paycheck until you reach your target balance.
Employer Retirement Accounts
Employer-sponsored retirement accounts, such as 401(k) and 403(b) plans, are crucial for building your retirement savings. Most employers will match a certain percentage of employee salary contributions. For instance, if Employer A matches 100% of the first 4% you contribute and 50% of the next 2%, you must contribute at least 6% to receive the full match.
To maximize your benefits, contribute enough to receive your full employer match. Additionally, consider investing the funds yourself in this account as many employer plans have a default investment option that may not align with your financial goals.
Brokerage Accounts
A brokerage account is a flexible investment account that allows you to purchase stocks, bonds, and other securities. Unlike retirement accounts, brokerage accounts do not receive the same tax advantages, but they also have fewer restrictions. In retirement accounts, contributions and earnings are tax-deferred until withdrawal, while income from dividends and capital gains in a brokerage account are taxed as they are realized.
Brokerage accounts have no annual contribution limits and no restrictions on withdrawals, making them suitable for longer-term investments (typically over a 5-10-year horizon). Be careful about investing funds you may need in the short term. Investments can fluctuate in value, and all investing involves risk, including the potential loss of principal. This account provides greater liquidity than formal retirement accounts, allowing for more flexibility in accessing your funds.
Roth IRAs
A Roth IRA is a unique individual retirement account that allows your investments to grow tax-free. Additionally, when funds are withdrawn in retirement, they are not subject to taxes. The longer contributions are invested in this account the more advantageous the tax-free growth will be. For 2024, the maximum annual contribution limit is $7,000, or $8,000 if you are over 50. Generally, you cannot withdraw funds from this account without penalty until age 59 ½, but there are exceptions. Notably, first-time homebuyers can withdraw up to $10,000 penalty-free (see full list of exceptions here).
Developing Your Savings Plan
Treat your monthly savings like a bill. Focus on building up your emergency fund and ensure you are contributing enough to your employer’s retirement plan to receive the full match. Automating your investments, whether on a monthly, bi-weekly, or weekly basis can help minimize market timing risk and ensure you follow through on your savings and investing goals. Ultimately, the best savings plan is one that you can follow.
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