There are all kinds of worthwhile reasons to save money: a home, college, retirement, even a vacation. But the very first thing to save for is a rainy day. If you don't have a safety net when the unexpected happens—a car repair, an injury, a job loss—you become vulnerable to making bad and expensive decisions.
What is a rainy-day account?
It’s money you set aside specifically for emergencies.
Rainy-day accounts can be difficult to build, but it’s important to make the effort. Try to accumulate one month’s worth of expenses.
Why is a rainy-day account important?
If an emergency hits and you don’t have a cash reserve, you can find yourself having to turn to expensive alterna- tives, such as credit cards, payday lenders, or tapping a retirement account—which comes with expensive fees and taxes.
How to build a rainy-day account
Start by opening a savings account at a bank. If you already have a checking account, keep it separate from your new savings account.
The goal of your rainy-day account is not to earn interest, so don’t be tempted by money-market accounts or other savings vehicles that promise higher potential earnings for your money but that also come with risk.
Make the rainy-day account your top saving priority
Saving for retirement is crucial, but before you worry about tomorrow, make sure that you’re protected today.
Build up one, three, or even six month’s worth of expenses in your rainy-day account before you start contributing to your retirement account.
What else to save for
Once you have built your rainy-day account you can start saving for other things. The three main savings goals are your retirement, an education for you or a loved one, and a down payment for a house.
Saving for retirement
Putting away money for retirement helps you tomorrow, but it also has benefits today—your retirement contribu- tions are tax deductible.
It’s important to start saving for retirement as soon as possible because the longer your money has to grow, the more it will earn.
Some companies even match some or all of their employees’ retirement contributions.
Saving for a home
Before a bank will give you a mortgage, it will expect you to contribute a down payment, typically between 5 percent and 20 percent of the purchase price. For a $200,000 home, that means you’ll need to save somewhere between $10,000 and $40,000.
Though the money you save for a down payment is not tax deductible, the interest that you pay on your mortgage is.
Saving for an education
529s are special accounts that provide tax breaks on the money you save for college or other forms of higher education. The contributions are not tax deductible, but they grow tax-free.