We have all heard of the 50-30-20 (50% on needs, 30% on wants, 20% on savings) rule of earning and spending money.

So let’s say you are able to achieve the perfect balance in your earnings and can start saving some portion of your income. The next steps to savings are the most crucial. Many will just let the savings rot in a checking account, never to be seen again until needed. However, this method has a lot of wasted potential. 

In this article, we will discuss various strategies for saving money and effectively creating wealth over the long term.

Inflation

Before we begin our journey to learn about wealth creation, it is essential that you understand why saving in a normal checking account is not optimal, and could even cause you to lose money.

So, what is inflation and why is it important? Inflation is the rate of growth of the cost of goods year over year. Every economy goes through inflation and the cost of goods keeps rising, sometimes at a nominal rate (1-3%) and sometimes at a steep rate (11-20%).

Let’s take an example, if a cup of coffee costs $1 in 2022 and the rate of inflation for that year is 10%, nothing else changed, the same coffee will cost $1.10 in 2023. And let’s say if the same continues for 2024, the same coffee will cost $1.21.

Why is this important? Let’s say you saved $1 in 2022 and just kept the money in your checking account. Well, if in 2022 you wanted to buy a cup of coffee with that money, you can easily take the money from the checking account, go to the coffee shop, and pay for the coffee because it still only costs $1. But wait, could you do the same in 2024? Unfortunately, you cannot. This is because when you extract your $1 from the checking account and head to the coffee shop, the shop is going to ask you to pay $1.21 and you are short 21 cents. Therefore, the value of your $1 decreased while it was sitting in your checking account, and you lost money gradually.

Well, how about you put that dollar into a savings account that earns 5% interest? When you go to the bank and take out the money in 2024, your dollar will have grown to $1.06. Still, it can’t buy you the coffee, however, you’re short by a smaller amount.

Now, let’s say you invested the dollar in 2022 into a stock account that gave you an investment return of about 22% over a period of two years. With this growth, your dollar has now increased to $1.22, allowing you to purchase your coffee with an additional cent remaining. Do you see where this is going?

So which strategy do you think is better? Saving money in your checking account? Putting it into a savings account? Or in this case, investing it in the stock market? Let’s delve into this vast topic.

Wealth creation strategies

As you saw from above, saving money in a bank account is not saving at all and is as good as shrinking the money. So what can/should you do with your savings, how should you invest?

There are multiple vehicles that help you save, invest, and grow your money. I’ll talk about the following few in this article:

1. Employee 401K
2. Roth or Simple IRA
3. Savings Account or CDs
4. Investing in Stock market
5. Paying off Debt (what? How is this savings? Hang on, I’ll explain)

Employee 401K

Many employers offer what they call an Employee 401K account. An Employee 401K account allows you to put pre-tax dollars into the account which is deducted directly from your paycheck. This is one of the most beneficial ways of saving and growing your savings. Here are the benefits of a 401K account:

1. It’s pre-tax dollars: Whatever you invest in your 401K is taken out before you pay any tax on it. You don’t pay any tax on the dollars when saving into a 401k; you only pay when you take out of it.
2. Money is directly deducted from your paycheck: If the money is already taken out before you get your paycheck, it’s as good as you never saw it, and are not worried about whether to save or not
3. Direct setup with your employer: It is pretty easy to set up with your employer and a lot of 401K plans offer various investment options based on your risk tolerance.
4. Money stays and moves with you: It is your money, so when you move out of the company, you take your 401K account with you
5. Employer contributions: Many employers either match your contribution or deposit a set amount in your 401K every year. This helps the money grow beyond just what you have added to the account.

However, there are a few caveats to having a 401K. Any money deposited in a 401K is put into your retirement account and can only be accessed after 59.5 years of age. Early withdrawal will result in a penalty on the withdrawal amount. The IRS provides hardship withdrawals for special cases, which are rare and case-by-case.

The other disadvantage is that there is a limit to how much you can contribute to your 401K. In 2024, that limit is $11,000. Many do not reach that limit so this is a manageable disadvantage. 

Roth or Simple IRA

What if your employer doesn’t offer 401K? Don’t worry, the IRS also offers investment accounts called Individual Retirement Accounts (IRA). IRAs are another vehicle for saving money with similar rules as the 401K except that you deposit post-tax money into these accounts (you can claim it back when you file taxes in case of a Simple IRA):

1. Money stays in the account and grows long-term until you are 59.5 years of age
2. Anything deposited in a simple IRA can be claimed back on your tax returns and therefore is tax-free dollars. Your earnings grow and are taxed only when you take them out
3. If you use a Roth IRA account, you can’t claim it back on your tax returns, however, the money grows tax-free which means you do not pay any taxes on whatever you take out.

The only stipulation again is that the money is locked away for the long term and if you want to withdraw early, you will have to pay a penalty to the IRS (Investopedia).

Savings Account or CDs

A savings account or CD (Certificates of Deposits) is a great way to invest in case you need easy access to the money and not have it tied away for retirement. Experts say you should always have 3-6 months of emergency money in an easy-to-access account. This is to have a contingency in case you lose your job or any other accentuating circumstances.

Savings or CDs offer interest rates between 1-6% per annum in the United States and are a good vehicle to keep adding to your savings over a period of time. A simple example is if you deposit $100 in an account with 5% APR, you will have $105 at the end of the year. 

Your account will grow into a savings account, however, the ROI (return on investment) is not as high as some of the other vehicles in this article.

Investing in the Stock Market

Investing in the stock market is another way of growing your savings and creating wealth in the long term. Many studies have confirmed that money grows in the stock market over a long period even if there are ups and downs in the market. Here’s a chart that shows the growth of $10000 in the stock market over a period of 20 years (Motley).

(https://www.fool.com/investing/2023/06/25/if-you-invested-10000-in-the-sp-500-20-years-ago/) 

As you can see, the best way to grow money in the stock market is to keep the money invested for the long term. There are various vehicles such as Bonds, ETFs, or individual stocks that will help grow your money based on your risk profile. 

Experts say if you have enough savings that you don’t need for a while, it’s best invested in a stock market versus kept in a current or savings account. If you don’t know what to invest in, you can simply buy ETFs that closely reflect the S&P or Nasdaq e.g. SPY, NASHQ, etc.

Paying off Debt

You might be wondering, how is Paying off Debt considered saving money? Well, consider this; let’s say you have a credit card that charges you 24% APR if you use it and don’t pay off the full balance. That is a lot. That means if you owe $100 on that credit card, by the end of the year, you will owe $124.

It goes to say that if you are able to pay off the full balance on your credit card, that is the best way to have savings and let your savings grow. Nonetheless if for unavoidable reasons you have to carry debt (in the form of education loans, credit card debt, etc.), it’s best to pay those off first before trying to save money. Obviously, it’s best to reduce your needs and wants so you can somehow put something into your savings.

Wealth creation goes beyond saving; it’s about choosing growth-focused financial vehicles that combat inflation and build value over time. While we’ve covered common options like 401(k)s, IRAs, and stock market investments, non-traditional choices such as real estate, small business investment, or even alternative assets can also play a role. The key takeaway is to keep money working for you, not sitting idle. With consistent, strategic investment, you can actively grow your wealth and enhance your financial stability for the future.