Originally published August 2020
Updated April 2023
“How much should I be saving? And where?” In the context of a financial plan, this question is the one I hear most from those seeking savings advice.
Money is finite. You have financial goals for today, goals for five years from now, and goals for 30 years from now that must all be balanced.
So how do you get the most bang for your buck when it comes to saving money?
If you follow me on social media, you’ll know I detest one-size-fits-all personal finance and saving advice. So below, I’m going to outline the financial principles you can use to decide how much to save and where to save it.
Always start with covering your assets today.
“An emergency fund is there to cover you when everything that can go wrong does.”
That means having an emergency fund. Some clients resist this savings advice because they don’t like having cash sitting around. But this thinking is wrong-headed.
An emergency fund is there to cover you when everything that can go wrong does.
Let’s say you work in oil and gas (this is Houston, after all), and a massive oil shock sends the local economy tumbling along with the stock market. Things get worse when you are informed that you are being laid off.
If you have an adequate emergency fund, you know you can still pay your bills, allowing you to calmly look for a new job.
If you don’t have an emergency fund, you could find yourself facing all sorts of bad choices: taking a terrible job, running up credit card debt, selling investments in a down market, or taking money out of a retirement account (which will incur taxes and penalties) to make ends meet.
How much cash should you keep on hand?
Consider your risk of unemployment and how many people depend on your income. A single professional with no children and a secure job likely needs about three months of expenses in the bank.
A married sole breadwinner with children and poor job security might need to keep 12 months of expenses in the bank.
Most of my clients keep three to six months worth of expenses in their emergency funds.
Treat Yourself (Tomorrow)
Once you’ve established your emergency fund, it’s time to turn your attention to longer-term goals.
That may feel counterintuitive, since you may have other short-term goals like buying a home or that hot new car you’ve always wanted.
But starting early is key when saving money and investing for retirement because time is on your side. Compounding is the most powerful tool you have to reach your retirement goals.
Most of you likely have an employer-sponsored retirement plan like a 401(k). I use a Good/Better/Best framework when considering these savings plans.
Good: Contribute something. Even if it’s a small amount, it’s better than nothing and will get you started.
Better: Contribute up to your employer match. If your employer matches employee contributions (many do), that means you’re eligible for freemoney. An employer match can be thought of as doubling your investment contribution - hard to beat!
Best: Contribute up to the maximum pre-tax annual salary deferral allowed by the IRS. For 2023, that amount is $22,500 for 401(k) plans.
By contributing to your 401(k), you’ll lower your income taxes today (your contributions are not subject to current income taxation), establish savings that grow tax-deferred, and set yourself up to enjoy years of compounding.
“By contributing to your 401(k), you’ll lower your income taxes…”
Will this alone be adequate to fund your retirement? Maybe — but not likely. Once you are maximizing your 401(k), the next savings vehicle to consider is an IRA. I wrote all about IRAs back in March of 2022.
The bottom line is that after you’ve established your emergency fund to CYA today, you should establish your retirement fund to treat yourself tomorrow.
Balance All the Rest
Now, you can turn your attention to the other goals on your mind: a home purchase, higher education for your children, or that new car your heart is set on.
Any goals that you intend to reach within 12 to 18 months should be funded with savings in a bank account. Stocks are too unpredictable to be useful investments for short-term goals.
Even bonds, which are more predictable, can suffer price declines (though those declines are typically more modest).
Knowing how much to save for a short-term goal is intuitive. Just figure out how much it will cost to meet the goal and how much time you have to save. Divide the goal cost by the number of months, and you’ll know how much to set aside on average each month.
Intermediate-term goals like higher education for young children can involve a bit more risk since you’ve got a bit more time. Most clients choose to fund higher education goals with Section 529 Plans because of the tax benefits.
Those benefits include tax-deferred investment growth and tax-free withdrawals to cover qualified higher education expenses. As with your 401(k), time is on your side if your children are young. Starting early is best; so consider making this your next priority after retirement savings.
At this point, where there are multiple goals over multiple time horizons with multiple risk tolerances attached, most clients seek out the assistance of a Financial Planner to help them prioritize savings since the math can get complex.
A Word About Debt
So far, I’ve ignored the possibility that you have debt.
But debt is a very common feature of living in the modern era. In general, it’s best to establish your emergency fund, take advantage of any employer matching in your 401(k) and then turn your attention to paying off high-interest debt.
Your instinct may be to pay off debt first, but that could lead to problems down the road.
Imagine you are gainfully employed with a modest amount of debt but no emergency fund.
Instead of building an emergency fund, you pay off the debt and then promptly lose your job.
With no emergency fund, you’re now left with no choice but to rack up new debt to make ends meet — and you’re right back where you started. This can be demoralizing and demotivating for even the most even-keeled individuals.
Summing It All Up
Here’s the TLDR version for those of you who scrolled all the way to the bottom:
- Establish your emergency fund
- Maximize your employer 401(k) match if applicable
- Pay off high-interest debt if you have it
- Fully fund your 401(k) (and maybe an IRA)
- Save for all the rest
If you’re already at #5 on the list, you might be ready to hire a Financial Advisor. Lucky for you, I happen to be one and would love to help you plan for and reach your financial goals.
Robert W. Baird & Co. Incorporated. Baird does not offer tax or legal advice
 This limit is adjusted upward periodically, so be sure to check the IRS website annually to see if you can sock away even more.
 For example: If you want to buy a home valued at $300,000 with a 20% down payment in 24 months, you’ll need to set aside $2,500 on average each month to have $60,000 in the bank when you are ready to buy.
 High-interest debts include items like credit cards and some private student loans. Most items that carry interest charges of more than 6% annually are good targets for being paid down.