A very common New Year’s resolution is to save more money. That’s a worthy goal, but I recommend that you maintain two savings accounts—an “If” savings account and a near-term “When” savings account.
“If” savings is your emergency fund. It’s for all of life’s if’s—if you incur significant medical or house repair expenses that are not covered by insurance, and mostly if you lose your job. I used to believe that having three to six months’ worth of essential living expenses in such an account was the right target. I now believe we should all have six months’ worth. The recession has shown me just had bad things can get, with the average unemployed person remaining out of work for about six months.
The other type of savings account, near-term “When” savings, is for items you spend money on every year but not necessarily every month—when the semi-annual property tax bill comes due, when your annual life insurance bill arrives, when you take a vacation, etc. Take the annual total of all such items, divide by 12, and automatically transfer that amount from your checking account to a separate savings account each month. When the bill comes due, just transfer the amount back into your checking account and make the payment from there.
Some people go even further, with separate savings accounts for each item—one account for vacations, another for property taxes. However, my wife and I find that maintaining one savings account for our emergency fund and one account for all periodic expenses works well.
There isn’t a one-size-fits all approach to deciding what to save for in your near-term “When” savings account. We don’t use our account to save for gifts, home maintenance, or vehicle maintenance, for example. We just let our monthly budgeted amounts for such items build up in our checking account. But we do use our separate near-term “When” savings account to save for our property taxes, life, home, and vehicle insurance premiums, and vacations.
If you don’t have a separate savings account for periodic expenses and bills, I recommend that you open one as soon as possible. It’s a relatively simple step toward building a well-oiled financial machine in 2010.