‘Failing to plan is planning to fail’ -attributed to Alan Lakein
I never want to go back into debt!!! I’m making sure of this by developing good money habits such as budgeting, living below my means and most importantly, saving.
In the past I had one savings account where I put in 10% of my paycheck. I was saving for my future, but nothing in particular. That money eventually went into covering overdrafts on my checking account and also paying credit card debt and some unnecessary items.
Now, I save towards a goal with a goal amount in mind. For instance if you are planning on buying a car, “buying a car” is your goal and then you set a limit for how much you want to spend on the car. How you save the money or where you keep it will depend on what you are saving for.
I’m going to take you through 3 types of savings funds that I have. I will not be discussing Retirement or College Funds at this time because I do not feel qualified to give advice on those right now. Please speak with a professional if you would like more information.
Starter Emergency Fund
The goal of having an emergency fund is to avoid going further into debt and for peace of mind. Life isn’t always going to go smoothly. Cars break down, pipes break, emergencies happen. I’ve found that the way I’ve reacted to these emergencies has changed since I set up my Emergency Fund. Life is less stressful now.
How much should you save?
500 if you make 20k or less per year and 1000 if you make more.
Where should you keep this?
I keep mine in a savings account at my local bank. I make approximately 1 cent in interest each month but that is ok. Remember this is an emergency fund, not something to make you money. You want it to be easily accessible in times of trouble. I’ve heard of people keeping it in cash in a safe at home. If that works for you and you wouldn’t be tempted to spend it, go for it.
Is the amount enough?
Yes. This is a starter fund for emergencies. If you are really budgeting you would be (hopefully) able to free up some money if your needs are more. This amount is also to make one uncomfortable enough to aim to finish paying off your debt (Dave Ramsey’s Baby Step 2) quickly.
You should set up sinking funds (discussed later) for things you know are coming up in the future. If your car is due for servicing in a few months, set up a sinking fund and put that in the monthly budget. That is not an emergency. An emergency would be the car breaking down unexpectedly.
Fully Funded Emergency Fund (FFEF)
Once you’ve become debt-free (except for the house, if you have a mortgage) you can now start to save for the unexpected. The goal is to save 3 to 6 months of your monthly expenses. You can choose to do 3 months if you are certain of the future for example you have job security etc. But if the future is more unpredictable you should aim for 6 (or more) months of expenses.
Where should you keep this money?
I still have my BS1 ($1000) in an easily accessible savings account but my FFEF is in a high yielding online savings account. You can also choose a money market account with great rates. Do your homework and find what works for you.
DO NOT put this money in mutual funds or buy stocks. This money is for an emergency and not for investing. Imagine needing the money at a time like this and losing it all because the stock market isn’t doing too well. I actually read a post by someone who did this because they were confused about mutual funds and money market accounts.
Sinking Funds
Christmas is not an emergency! You know it comes at the same time every year. If you plan on giving gifts this year, the best thing to do is to start saving now. Start a sinking fund.
Everydollar.com defines a sinking fund as “a strategic way to save money by setting aside a little bit each month”.
So, if you plan on spending $120 (for example) you can put aside $10 each month, instead of taking out the entire amount from one paycheck.
I use sinking funds for my car insurance. I make 2 payments a year, this comes up cheaper than making monthly payments. However, I set that money aside in my savings account each month so I don’t “lose” a hefty amount in one paycheck.
Where should you keep this money?
This depends on how much you are saving and what you are saving for. I prefer to use cash for most of my expenses so for sinking funds for things like Christmas and birthdays, I keep them in cash envelops in a safe place. However, I keep my car repair sinking fund in a separate high interest savings account that I can withdraw from if my car needs repairs.
You do not need to open separate accounts for each sinking fund that you set up. It is fine to keep them in the same account, as long as you keep track of how much you put in and for what. However, I would encourage you to keep it separate from your checking account because there is temptation or likelihood of using that for something that it wasn’t originally intended for.
Remember to take baby steps. Developing a habit of saving is a good step to take towards getting and staying debt free.