Physical fitness is not something that happens by accident. Typically, a physically fit body is the result of good health habits, such as healthy eating; regular exercise; and the input from a professional in the health industry. Oppositely, poor health habits, such as eating unhealthy food every day; little or no exercise; and no input from a health professional, generally result in an unhealthy physical body.
Financial fitness typically follows this same pattern. Financial fitness is usually the result of good financial habits, such as paying yourself first; making savings part of your regular financial routine; not living above your means by spending more than you make; and having a financial professional guide you along your financial path. Oppositely, if you have poor financial habits, such as not saving any money; accumulating too much debt; and not receiving any input from a financial professional, the result generally is poor financial health.
One essential financial exercise to focus on is saving. This one exercise alone can have a huge impact, both in the short term and the long term, on your overall financial fitness. This article outlines a few basic areas of savings that you should focus on in order to move you forward along your journey towards financial fitness.
Exercise 1: Understand the Types of Savings Vehicles
The first exercise is to understand the different types of savings accounts available. Several different accounts exist, but let us focus on two major areas of savings: Short and long term savings plans and the accounts established for these two time horizons. These two different types of accounts have very different purposes, and accordingly their features are very different. Let us look at each in detail, and the pros and cons associated with each.
The short term accounts are established for money that will be used in the near future, for example over the period of a month. This money is earmarked for activities such as paying bills and children’s expenses. An example of this account would be a checking or savings account at a bank. A major benefit of this account is the ease of access to the money. Typically, there are no fees to withdraw the money, which is another major benefit. A downside to this short term account is the low interest rates paid on them. A typical interest rate associated with such an account is, on average, 1%. Therefore, while this account is ideal for short term savings, it is not well suited for long term savings, due to the low interest rates.
The long term savings accounts are typically established for money that will be used in retirement years. Therefore, they are earmarked for usage after a certain age, which is typically age 59 and ½. Just a few examples of a long term account are a 401K plan and a 403B. There are several benefits for this type of plan. One benefit is that these accounts typically yield higher interest rates than the short term savings accounts. Another benefit is the money that will be available during your retirement years, years where most people are not as physically able to work as in their younger, healthier years. A downside to this long term account is the time horizon. It is earmarked for retirement and therefore not supposed to be withdrawn prior to the designated retirement age, which in most cases is age 59 and ½. If the money is withdrawn prior to that designated age, penalties are typically charged. Therefore, to maximize such an account, the money should not be touched until the appropriate age is reached. Another area to focus on with your long term savings account is the taxation, and how taxes will be applied when you withdraw the money.
Savings Vehicle Action Step: Examine the accounts you currently own. Do you have an account established for short term needs, such as a bank account? And do you have a long term savings account that is earmarked for your retirement? If you are missing either one of these accounts, the first step is to establish the account as soon as possible. Once you have the accounts established, the next step is to determine the appropriate funding for each – how much should be money should be saved in the accounts?
Exercise 2: Pay Yourself First
On a monthly basis you have financial obligations. Some of these include paying your car note, children’s expenses, and your mortgage. Without neglecting these payments monthly, a priority every month must also be to pay you, and to do it first. For so many people, they pay their bills, and then if anything is left over at the end of the month, this is what they pay themselves. However, if you are to develop a habit for saving, paying yourself must be done before any other things are paid. As a financial professional I am often asked how much money should be saved. My advice is to save at least of 10% of all income earned. Once this habit has been developed, you should consider increasing this percentage. There is no such thing as something for nothing. Saving 10% of your income may mean giving up something in the short term, such as eating out for lunch, and instead taking your lunch with you to work. However, living below your means for a short while will pay off tremendously in your financial future.
Pay Yourself First Action Step: Look at your total income on a monthly or biweekly basis, and calculate how much 10% of that income will be. This will be the amount you set aside, either monthly, or biweekly, depending on how frequently you get paid. This money should be saved in an account that will remain untouched.
With anything in life, knowledge is not power. It is what you do with that knowledge, and the action you take that will make a difference in your life. After reading this article, the next step is to take action. Do not wait one more day to start saving money for you, your family, and your futures. Make the decision today that you will take the necessary action to implement a savings plan for you and your family.
Article by Lisa Sehannie