Dear Vice Column,
Despite recession fears looming for most of 2022, I've managed to keep my office job, which covers my basic expenses with enough leftover to spend on life. Due to anxiety about layoffs, I've been living below my means and have squirreled a decent amount into savings. I don't know much about investing, and have been scared to start due to doom and gloom headlines about the stock market — but I know I'm losing spending power by keeping too much cash. What are a few things I can do to build smarter money habits in 2023?
– Scared into saving
Dear Scared into saving,
Congratulations for keeping your job, and managing to save some money during a period of high inflation. You're right that having too much cash on hand will put you at a disadvantage as it won't keep up with inflation. Hopefully at a bare minimum you're keeping your money in a high yield savings account, which offer much higher interest rates than a checking or standard savings account. This could be the first thing to check to set yourself up financially in a better way for 2023. Other low risk ways to earn interest off your cash include buying I bonds or opening certificates of deposit (CDs) — but if you need your money to be more liquid, these may not be the best options for you.
Onto your other point about investing, while it's scary to think about losing money in the stock market, another way to think about it is buying shares at a discount, as eventually the market should go up again. However, I don't know how much you've saved so before addressing that, ideally you'd have at least 3-6 months worth of living expenses in emergency savings in the event of a job loss or unexpected expense. The monthly amount should include housing payments, car payments, utilities, food and medicine — plus health insurance premiums if you're currently covered by your employer. The number of months you save up for is up to you, depending on whether you straight up quit your job or if you're laid off with severance and the ability to collect unemployment insurance.
If you've built up your emergency fund or at least have committed to adding to it regularly to hit your goal, does your employer offer a 401k match? Although participating in a 401k comes with market risks, they're a great savings vehicle for retirement and if your employer matches, that's free money going toward your future. Start by contributing enough to get your match, and do some research about choosing funds that match your risk tolerance. Target retirement funds based on your targeted retirement year are often a default plan. They offer diversification and adjust for risk as you near retirement.
If you still have some cash left, maybe put some into a vacation fund or some other short term savings goal such as a new car or a down payment for a house or some type of splurge item. 2022, and the past few years with the pandemic have been tough, and it's important to save for the future as well as live a good life now. Living below your means got you some savings, and if you meet your savings goal, spend it!
Back to investing. Contributing enough to a 401k to get your match might be the first step. Next, you might want to open up a Roth IRA account with the ultimate goal of maxing it out each year as long as you're eligible (there are salary caps to be able to participate in a Roth IRA). Once you've set up a Roth IRA, you can invest in index fund ETFs that track against the S&P 500, Nasdaq, etc. Doing so instantly diversifies your investments versus selecting individual stocks, but you'll have to pay a management fee. Luckily there are many low expense ratio ETFs to choose from. Many brokerages offer commission-free trades so regularly investing to take advantage of dollar cost averages can help you take the fear out of investing — though all investments do come with a risk.
That's more than a few ways to help you start 2023 with a goal toward increasing your earning power with your existing cash. Investing in the stock market is one of the best ways to build wealth over a longer period of time to take advantage of compound interest. Tax diversification via Traditional and Roth 401k/IRAs as well as taxable brokerage accounts can help you assess how you want to get started.