Saving for Future Purchases

Earning, spending and saving

Most people earn income by working for an organization: a business, a nonprofit or a government entity. Some also earn it from self-employment, rental properties, government programs, investments or retirement accounts. Most of that income gets spent on products that address their problems, needs and wants.

What is not spent can be saved. People save for significant future purchases, such as a car, a home or college tuition. They save for emergencies, such as losing a job or getting sick. And they save so they will have a source of income in retirement, after they stop working.

Saving creates a personal asset, something of value that you own. Savings may also earn interest, which is income you can use now or leave in the account for later. How much interest you earn depends on the interest rate, the amount you have saved, conditions in the economy and the type of account the money is in. Keep $5,000 for a year in an account paying 4% and you earn about $200. At 0.5%, the same $5,000 earns about $25.

What makes saving hard

Some barriers are about the money itself. Inconsistent income, such as tips that swing from week to week or hours that get cut, makes it hard to set aside the same amount every month. And when recurring expenses exceed income, there is nothing left over to save.

Other barriers are psychological:

• Instant gratification is wanting the reward now rather than later. A concert this weekend feels more real than a car next spring.
• Lifestyle inflation is spending more every time you earn more. A $300 raise that turns into $300 more in rent leaves your savings exactly where they were.
• Impulse buying is buying things you had not planned to buy, often because they were in front of you at the right moment.

Some programs are built to work against these barriers. An automated savings plan moves a set amount of income into savings during each pay period, so the money is gone before instant gratification gets a vote. A retirement savings plan lets you save on taxes when you save for retirement, and a health savings account lets you save on taxes when you set money aside for health-related expenses.

How PESTEL factors affect saving

PESTEL factors (political, economic, social, technological, environmental and legal) can change what savings are worth and how much reason people have to save. Economic, political and legal factors are good examples.

Economic factors. The stability and performance of the economy affect people's incomes and the cost of living. In a weak economy, people lose jobs or hours. In a strong economy, the cost of living can climb. Either one can leave less income after paying necessary expenses, which makes saving harder.

Inflation, an increase in the prices of goods and services, is an economic factor that works directly on savings. It erodes the purchasing power of savings, because the same money will buy fewer goods and services in the future. When people expect that loss, some decide saving is not worth it, so inflation can discourage saving.

Political factors. Government tax policies can encourage saving, for example by letting people put part of their income into an account designated for retirement, health care, childcare or other purposes without paying income tax on it that year.

Legal factors. Government agencies regulate financial institutions, such as commercial banks and credit unions, to improve consumer protection and keep the institutions financially stable.

Where to keep savings

A savings vehicle is wherever you keep your savings. The ones banks and credit unions offer include savings accounts, money market accounts and certificates of deposit.

A savings account is a deposit account that typically pays interest. It is insured by the federal government up to a maximum amount ($250,000 as of 2024), which means you do not lose your deposit if the bank goes out of business. Some savings accounts charge a monthly fee, and the minimum deposit, interest rate and fees all differ by institution.

A money market account is similar and also federally insured. Compared with a savings account, it may require a larger minimum deposit and charge higher monthly fees, but it may pay a higher interest rate and give you easier access to your cash.

A certificate of deposit (CD) is also similar and federally insured. It typically pays more than either of the others, but you are restricted from withdrawing the money for a set period, usually one month to five years. A CD typically requires a larger minimum deposit and charges no monthly fee.

Money you are not saving is usually held as cash or in a checking account, a federally insured deposit account designed for frequent transactions: deposits, withdrawals, debit card purchases and payments. Checking accounts pay little or no interest and may charge monthly maintenance fees or overdraft fees, so people pick one for its fees, its access (ATMs, online banking) and how easy it makes day-to-day spending.

Some people keep savings in a mobile payment account, which makes the money easy to spend, or a cryptocurrency account, which they hope will gain value as an asset. Unless an insured financial institution offers them, these accounts are not federally insured, and they typically pay no interest.

Building a savings plan

A savings plan answers two questions: how much, and where.

How much depends on your personal and financial goals and on your current income and expenses. People tend to save more when they have defined goals and face fewer barriers, which is why a plan starts with a goal, a dollar amount and a date.

Where depends on how much you are saving, what the money is for, how long you have, PESTEL factors such as inflation, and the benefits and costs of each savings vehicle. When you compare financial institutions, look at interest rates, fees, minimum deposit requirements and potential risk, along with location, convenience and reputation.

Expect tradeoffs. Accounts that pay higher interest often come with higher minimum balances or other requirements, and a CD's higher rate comes with restrictions on withdrawing the money before its term ends.