Saving: The Keys to Success

By: AARP Education & Outreach | Source: AARP.org | April 13, 2006

Saving money is crucial to your current and future security. Here are some key ways to make saving a natural part of your life.

Build an emergency fund. Life is unpredictable. Your car may break down; you could lose your job; or you could have a medical emergency. You never know what can happen. Set aside enough money to cover basic living expenses for three to six months. Put this money in an account from which you can withdraw money immeidately and without a penalty. Figure out how much you should have available in case of an emergency.

Pay yourself first. A key to becoming a saver is to pay yourself first. It's a great way to get in the habit of saving. It may be difficult at first, but before long, you will be very happy that you are saving and paying yourself first, not last. Join AmericaSaves and commit to your own wealth building program.

Do it automatically. Pay yourself first automatically. It's easy to do electronically. Simply have a certain amount from your paycheck deposited into a financial account. You'll complete a form authorizing your bank (or whatever institution) to receive a portion of every paycheck and deposit it into your savings account. This is a great way to build up your savings—if you don't see the money, you won't miss it.

Save 10% of your paycheck. A good rule of thumb is to save 10% of your paycheck. If this feels too high, try 5% for a while. Then, try to work up to saving 10% of your earnings. You'll thank yourself over and over when you retire.

The power of compound interest. A simple saving strategy is to leave your money alone and let it accumulate over time, or "compound." Thanks to the power of compounding, the more money you save, the faster it grows. That's because you earn interest not only on what you save, but also on the interest generated. The earlier you start to save, the more dramatically your money can grow.

Example: Let's say you start out with $100 and it earns 5% compound interest. When your interest is compounded, the bank takes the interest that your account has earned during the previous day, week, month, or year. It adds that interest to your principal and then calculates your new interest payment. If you receive 5 percent compounded interest on a principal of $100, your investment would grow like this:

Year 1: $105.00
Year 2: $110.25
Year 3: $115.76
Year 4: $121.55
Year 5: $127.63

Use a calculator to see how much compounding improves your nest egg over time.

Doubling Your Money—The Rule of 72

How long will it take for your investment to double with compound interest? To find out, use the Rule of 72. Divide 72 by the interest rate you expect to receive on an investment. For example, if your investment earns 6 percent interest, your money will double in 12 years (72 divided by 6 equals 12).

Time Is Money

If you save on a regular basis, your dollars work even harder for you if your interest is compounded. The chart below will help you determine how much one dollar, invested today, will be worth when you retire.

AARP's Money Matters Tip Sheets on Savings Tips and Cost Cutting Tips have more information and action steps.