A nest egg is a large amount of money that someone saves and/or invests to meet a certain financial goal. Usually, a nest egg focuses on longer-term goals such as saving for retirement, paying for a child’s college education or buying a home.
A nest egg could also help you handle emergency costs — such as medical bills, pricey home fixes, or car repairs. There is no one answer for what a nest egg should be used for, as it depends on each person’s unique aims and circumstances.
Building a nest egg requires some planning and commitment, and this guide will help you get a strong start toward your savings goal.
Related: Weekly budget pros and cons
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Understanding How a Nest Egg Works
There is nothing mysterious about learning how to build a nest egg, but there are a few things to know about how to successfully save a larger pot of money.
- You have to have a plan. Unlike saving for short-term goals, building a nest egg takes time and you need a strategy. A common strategy is to save $XX amount each month or each week.
- You need to save your savings. This may sound obvious, but if you tell yourself you’re going to save a certain amount every week or month, you have to put it in a savings or investment account of some sort. If you “save” the money, but it’s available in your checking account, you could spend your savings unintentionally.
- Don’t touch your nest egg. The flip side of that equation is about spending: In order for your nest egg to grow, you have to make it untouchable. Retirement accounts are a good example of this. If you withdraw money from your 401(k), say, before a certain age, you could face a big penalty. When saving a nest egg for emergencies or for a goal like a home purchase or landmark birthday event, you have to keep that money equally out of reach and protect it.
Now let’s look at the fun part: How you acquire that nest egg.
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Step 1: Set a SMART financial goal
The SMART goal technique is a popular method for setting goals, including financial ones. The SMART technique calls for goals to be (S)pecific, (M)easurable, (A)chievable, (R)elevant and (T)ime bound.
With this approach, it’s not enough just to say, “I want to learn how to build a nest egg for emergencies.” The SMART goal technique requires you to walk through each step:
- Be Specific: How much money is needed for an emergency? One rule of thumb is to save at least three months’ worth of living expenses, in case of a crisis like an illness or layoff. But you can take another angle: Maybe you just want $1,800 in the bank for car and home repairs.
- Make it Measurable and Achievable: Once you decide the amount that’s your target goal, you can figure out exactly how to build a nest egg that will support that goal. If you want to save $1,800, for example, you’d set aside $200 per month for nine months — or $100 per month for 18 months. Be sure to create a roadmap that’s measurable and doable for you.
Last, keeping your goal Relevant and Time-bound is a part of the first three steps, but it also entails something further: You must keep your goal a priority. And you must stick to your timeframe, in order to reach it.
For example: If you commit to saving $200 per month for nine months in order to have an emergency fund of $1,800, that means you can’t suddenly earmark that $200 for something else. (You could, of course, but then your goal would fall off track.)
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Step 2: Create a budget you can live with
As we just discussed, it’s vital to have a plan in order to create a nest egg — for the simple reason that saving a larger amount of money takes time and focus. A budget is an excellent tool for helping you save the amount you need, steadily over time. But a budget only works if you can live with it.
There are numerous methods to manage how you spend and save, so find one that suits you as you build up your nest egg. There’s the 50-30-20 plan, the envelope method, the zero-based budget, etc. There are apps that can help you budget, as well as entire blogs and websites devoted to the topic.
Fortunately, testing budgets is fairly easy. And you’ll quickly sense which methods are easiest for you.
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Step 3: Pay Off Debt
Debt can be a major roadblock in building a nest egg, especially if it’s high-interest debt. Those who are struggling to pay down debt may not be able to put as much money into savings as they would like. Prioritizing paying down debt quickly can help save money on interest and reduce financial stress. Adding debt payments into a monthly budget can be one smart way to make sure a debt repayment plan stays on track.
If you’re having trouble paying down a certain debt, like a credit card or medical bill, it might be worth calling the lender. In some cases, lenders may work with an individual to create a manageable debt repayment plan. Calling the lender before the debt is sent to a debt collector is key, as many debt collectors don’t accept payment plans.
Two debt repayment strategies
Here are two popular debt repayment strategies that might be worth researching: the highest interest rate method and the snowball method.
The highest interest rate method focuses on paying off the debt with the highest interest rate as fast as possible, because the interest is costing you the most. This method can save the most money in the long run.
The other option is the snowball method, which can be more motivating as it focuses on paying off the smallest debt first while making minimum payments on all other debts. When one debt is paid off, you take the payment that went toward that debt and add it to the next-smallest one “snowballing” as you go.
This method can be more psychologically motivating, as it’s easier and faster to eliminate smaller debts first, but it can cost more in interest over time, especially if the larger debts have higher interest rates.
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Step 4: Make it automatic
Behavior research is pretty clear: The people who are the most successful savers don’t mess around. They put their savings on auto-pilot, by setting up automatic transfers based on their goal.
Behavior scientists have identified simple inertia as a big culprit in why we don’t save. Inertia is the human tendency to do nothing, despite having a plan to take specific actions. One of the most effective ways to get around inertia, especially when it comes to your finances, is to make important steps automatic.
Set up automatic transfers to your savings account every week, or every month. While you’re at it, set up automatic payments to the debts you owe. Don’t assume you can make progress with good intentions alone. Technology is your friend, so use it!
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Step 5: Start investing
The same is true of investing. Investing can be intimidating at first. Combine that with inertia, and it can be hard to get yourself off the starting block. Also, you may wonder whether it makes sense to invest your savings, when investing always comes with a possible risk of loss (in addition to potential gains).
You may want to keep short-term savings in a regular savings or money market account — or in a CD (certificate of deposit), if you want a modest rate of interest and truly don’t plan to touch that money for a certain period of time. But for longer-term savings, especially retirement, you can consider investing your money in the market.
You can also set up a brokerage account and start investing yourself. Whichever route you choose, be sure to make the contributions automatic. Investing your money on a regular cadence helps your money to grow in two ways: first, because regular contributions add up; second, because you can harness the power of compound interest.
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The power of compounding
When saving money to build a nest egg, whether in a savings account or a retirement account, compound interest can be a major growth factor. Put simply, compound interest is interest that you earn on interest.
The Rule of 72 is a handy equation that can estimate when an initial fixed-rate investment will double in value. Divide the number 72 by the investment’s interest rate (also known as the expected rate of return).
That number will show how many years it will take the initial investment to double, and every time that number of years passes, the investment will double again.
But how do you get a fixed rate of return, or even a variable rate of return that will help your money grow?
Many people choose to invest their money to build their nest egg, rather than place it in a savings account that offers typically low interest rates. While not all investments have a guaranteed return, the money earned on investments can be reinvested in a manner similar to how compound interest works.
It’s worth noting that unlike deposits which are typically guaranteed by federal deposit insurance in the banking world, investments like stocks, mutual funds, and bonds can fluctuate with market conditions. There is no guarantee someone will make money from their investments and they can lose value.
That being said, stocks tend to have the highest return over many decades. Bonds can provide higher returns than savings accounts, but less than stocks usually do. However, bonds are typically considered less risky than stocks.
Mutual funds and exchange-traded funds (ETFs) are more of a mixed bag, as the risk associated with these funds varies based on the underlying risks of the stocks, bonds, and other investments held by the fund.
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Like most financial decisions, building a nest egg starts with articulating goals and then creating a specific plan of action to reach them. Using a method like the SMART goal technique, it’s possible to build a nest egg for retirement, to buy a home, pay for a child’s education (or your own), or other life goals.
Because a nest egg is typically a larger amount of money than you’d save for a short-term goal, it’s wise to use some kind of budgeting system, tool, or app to help you make progress. A budget can also help you get out of debt, which tends to be a hurdle when you’re attempting to save.
Perhaps the most important ingredient in building a nest egg is using the power of automation. Use automatic deposits and transfers to help you save, to pay off debt, and even to start investing.
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