Choosing the Right Account for Common Savings Goals

In the previous lesson with my wife, I taught her about various investment vehicles available at our disposal. This time we discussed choosing the right tool for the job; that is, choosing the best investment option available for various savings goals.

Tools
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Common Savings Goals

First, we reviewed some of the more common savings goals. I purposefully excluded other financial goals, such as debt elimination, from this list.

  • Saving Money for Retirement
  • Saving Money for College
  • Saving Money for Emergencies
  • Saving Money for Down Payments

Obviously, these warrant different investment strategies, vehicles, and tools to get the job done.

Saving Money for Retirement

This type of saving requires long-term approach using high growth potential investments such as stocks, bonds, REIT, ETFs, and Mutual Funds. For us, the best tools for the job are 401k and Roth IRA.

  • 401k — This is my favorite tool for the job due to several advantages, the best being free money from company match. Other advantages include:
    • Easy to save money because the whole process can be automated; specifically contributions are deducted before I even get my paychecks
    • Regular contributions can help nervous investors hang on through down and volatile markets
    • Easy to build diversified portfolio and maintain good asset allocation through easy and inexpensive re-allocation process
    • Total contribution for each year is tax deductible
    • Money grows tax deferred
    • Money is accessible at the earlier retirement age of 55
  • Roth IRA — This is another good tool that I use concurrently with 401k. If I couldn’t contribute the maximum amount to both 401k and IRA, I would contribute up to the company matching limit for the 401k first, maximize our IRA contributions, and then put the rest into 401k. Advantages of Roth IRA include:
    • The account is completely sheltered from capital gains tax, and any taxes normally associated with dividend, interest, and fund distribution
    • There is no tax at the time of withdrawal
  • There are also other types of retirement plans that we don’t use, but might be right for your situation.

Saving Money for College

This is something that we went through recently, and as you know, we started a 529 College Savings Plan for our son not too long ago. Similar to retirement, this type of saving requires long-term approach using high to moderate growth investments such as stocks, bonds, REIT, ETFs, and Mutual Funds. For us, the best tools for the job are 529 Plan and Coverdell Education Savings Account.

  • 529 Plan — I think this is simply the best option, however the particular 529 plan must be chosen with care. Some plans are downright awful due to their expensive fees and poor investment options. For our New York’s 529 plan the advantages include:
    • Easy to save money because the whole process can be automated. We automatically transfer a small sum from our checking account to the plan each month.
    • The account is completely sheltered from capital gains tax, and any taxes normally associated with dividend, interest, and fund distribution
    • There is no tax at the time of withdrawal for qualified education expenses
    • High annual contribution limit, and it is New York State tax deductible
    • Similar to 401k, it’s easy to set up asset allocation, and re-allocate the portfolio
  • Coverdell Education Savings Account — We are unlikely to use this option. However, if we’d planned to save for a 4-year private college and need upward of $400,000, we will probably have to use Coverdell to overcome 529 plan contribution limits.

Saving Money for Emergencies

This type of saving requires high liquidity (you can get the money quickly and easily) using low-risk investments such as high yield savings account, high yield money market, short-term CD, and short-term Treasury securities (e.g., T-bill).

We have a portion of our emergency fund in our normal banking account (through a traditional financial institution, like Citibank and Chase) and another portion in our brokerage account (through a discount brokerage firm, like TD Ameritrade and Charles Schwab). However, I don’t like the idea of keeping all of our emergency fund in a low growth account, so I took a calculated risk and invested a portion of it in riskier investments.

Saving Money for Down Payments

This is similar to saving money for emergencies, especially if it’s saving money for a house. The time horizon is normally around 2-5 years and the goal is to grow the money at moderate pace while protecting the capital from any kind of drastic loss. As such, I would take same investment approach as I would for emergency saving.

However, I must admit that when I was saving money for our house, I couldn’t resist the temptation and invested some money in the stock market anyway. Luckily, I didn’t take any big hit before I purchased the house. Otherwise, the possibility of owning a home could have gone up in smoke; especially the way the New York housing market took off in late 90s and early 2000s.

Well, that was all we discussed this time around. Now let me ask you: Are you using the right tool for the job?

Other lessons:

About the Author

By , on Oct 26, 2007
Pinyo
Pinyo is the owner of Moolanomy Personal Finance. He is a licensed Realtor specializing in residential homes in the Northern Virginia area. Over the past 20 years, Pinyo has enjoyed a diverse career as an investor, entrepreneur, business executive, educator, and financial literacy author.

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Leave Your Comment (One Comment)

  1. Jonathan says:

    Pinyo, this is an excellent indepth look at the various savings tools and their relevance to individual circumstances. High liquidity saving options are always best for emergency funds.

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