There’s almost no better feeling than calculating your savings at the end of the month and seeing that you’ve got a lot to put away. It’s such a positive force and makes you feel even more empowered to save for the future.
So when I saw a question on Quora about how to use savings wisely, I wanted to chime in …
I’m able to invest $1500 of my monthly take home pay. Would it be wise to put all of it into a low cost index fund like Vanguard every month?
As you can imagine, this is a good situation to be in. Here’s what I recommended.
What should I do with my savings each month?
Absolutely!
But …
(You knew there was a but)
While investing the money into an index fund (presumably in a tax-favored investment vehicle) makes a ton of sense, it isn’t the first thing you should do.
I’m not assuming anything about your financial situation (except that you’re in a good position to be saving so much each month), so hang with me a bit to make sure I answer your question fully.
Here’s what I’d ask you first.
- Are you in debt?
- Do you have a fully funded emergency fund? Meaning, do you have 3–6 months worth of expenses in an easy-to-access savings account?
- Do you have short-term savings goals that you need to address relatively soon, like buying a house?
If you’re in debt …
Pay it off first. Especially if it’s credit card or student loan debt.
Just get rid of that albatross around your neck.
Getting rid of your debt allows you to invest from a solid position; you’re focused on making money, and not the amount of money you owe.
If you own a house with a mortgage, think about taking $250 of that $1500 each month and applying it to the principal on your mortgage. It can save you 5 years on a 30-year loan.
If you don’t have an emergency fund …
Stash 100% of that $1500 into a new savings account clearly named “Emergency Fund.”
This is your “oh no something bad happened” money.
Because (spoiler alert) bad things do happen. You lose your job. You get a big medical bill. Your car breaks down. Your roof caves in.
There’s no worse feeling that having to scrounge around or go into debt to pay for something unexpected.
The going recommendation is to have 3–6 months of your expenses put aside in an emergency fund (or 2 months per person in your family, whichever you’re more comfortable with).
If you have a short-term savings goal to meet …
Open up a new savings account (separate from your emergency fund) clearly called “House Fund” or “Wedding Fund.”
Calculate how much you’ll need to reach your goal, when you need to reach the goal, and figure out how much you need to save each month to get there.
The easiest way to ensure you hit your short-term savings goal is to automate your savings. (Here’s how we did it to save for a downpayment on our house.)
If you have no debt, have an emergency fund and have no short-term savings goals …
Then yes! Invest in Vanguard index funds.
They’re the cheapest on the market sold by the most ethical investing company in all of history.
Don’t believe anyone who tells you that actively managed funds are better options than index funds — they aren’t. In fact, over the past 15 years, more than 90% of large-cap, mid-cap and small-cap managers have trailed their indexes … and charged investors MORE for it (source).
If you have $1,500 to save each month, you’ll likely max out your Roth IRA contribution quickly (the contribution limit for 2017 is $5,500 or $6,500 if you are 50 or older).
Congratulations. You’re in a great place to make some successful financial decisions.
You’re already #winning.
Photo by rawpixel.com on Unsplash
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