Of all the things you could do with money, parking it in a savings account isn’t likely to move the excite-o-meter. But it does have the advantage of being highly useful. So useful, in fact, that I want to encourage you to not just double down on the idea, but to triple down on it.
Here are the three types of savings I encourage everyone to have.
An emergency fund
You knew this one was coming. And yes, I agree with the majority of financial writers and advisors who peg three to six months’ worth of essential living expenses as the right amount to strive for here.
So, which is it? Three months’ or six months’ worth of living expenses? It depends on how many breakable moving parts you have in your life. If you’re single, rent an apartment, and your job is fairly secure (or at least your job skills are in demand), then you’re fine at the three months’ side of the spectrum. But if you have a spouse and some kids depending on you, own a home, and your job is even a little bit tenuous, you really should have six months’ worth of living expenses in reserve.
A big-ticket item replacement fund
Speaking of breakable moving parts, a house has lots of these, many of which are expensive. Okay, your roof doesn’t actually move (at least it shouldn’t), but it’ll need to be replaced one day. And that’ll be an expensive day. Same thing with your furnace, air conditioner, water heater, washer and dryer, and on on. And same thing with your car.
How do you save for such things? Once your emergency fund is built, if you had been saving 10%, keep saving 2% for a big-ticket item replacement fund and redirect 8% toward investing. If you had been saving 15%, keep saving 3% and redirect 12% toward investing.
When we bought our house, we knew the furnace and air conditioner were not long for this world, so we started putting money aside each month earmarked toward their replacement. They ended up lasting a bit longer than we thought they would, so when we finally had to replace them we had more than enough in savings. Then we renamed that fund our “car replacement fund” and have been adding to it for the eventual replacement of our oldest car.
A periodic bills and expenses fund
This is an account (separate from your emergency fund and big-ticket item replacement fund) where each month you transfer one-twelfth of the annual amount that you have budgeted for bills and expenses that need to be paid sometime during the year but not every month. Examples include a semi-annual auto insurance premium, an annual life insurance premium, vacations, and Christmas presents. When the bill or expense needs to be paid and the money is there because you’ve been saving for it each month, that’s a beautiful thing.
Building this savings account doesn’t require using a portion of your overall savings allocation. It just requires making sure to include all periodic bills and expenses on your monthly cash flow plan and then transferring the total of all such monthly amounts into a separate savings account each month. For example, if your car insurance costs $600 every six months, there should be a $100 allocation for car insurance listed on your monthly cash flow plan. Each month, you transfer that $100, along with all other monthly allocations for periodic bills and expenses, into a savings account. When the bill or expense comes due, you just transfer the amount you need from savings to checking and make the payment.
If finding the money to save looks like a challenge, just start where you can. To increase your savings rate, think about the financial framework I’ve written about before where you orient your finances with generosity, saving, and investing coming before anything else (see The Priorities That Lead to Financial Success and Satisfaction). It may take some time to get there, but begin moving in that direction.
Think of it this way. If you work a 40 hour week, the four hours you work on Monday morning would be devoted to giving generously to support God’s work in the world. The four hours you work on Monday afternoon would be devoted to saving and investing in order to build a solid financial base for your family today and provide for your family in your later years. Then, all the money you earn Tuesday, Wednesday, Thursday, and Friday is available for spending. That’s not so unreasonable, is it?
Take it to Heart: “Precious treasure and oil are in a wise man’s dwelling, but a foolish man devours it.” – Proverbs 21:20 (ESV)
Take Action: Use separate savings accounts for each of the three purposes described in this post.