In the first two installments of the “3 B’s,” we looked at budgeting and beating debt. Today, we’ll look at the third critical piece of saving, “building savings.”
WHY? Savings have three purposes:
- To meet unforeseen emergency expenses.
- To plan for short-term needs and wants.
- To avoid creating debt.
So how much savings should one have? The easy answer, of course, is that you should have enough to satisfy the three purposes of savings. Let’s take each of those three apart to come up with a systematic way to determine how much any given individual or family should have in savings.
When it comes to planning for unforeseen expenses, an individual or family should have enough in emergency savings to cover basic expenses for the amount of time one might be foreseeably without work—which will depend on one’s occupation, geography, personality, etc. So, if you happen to be a government employee where layoffs are rare, you will likely need fewer months of emergency savings. However, if you happen to be in a profession where reemployment would take a considerable length of time, you should probably plan on 6 to 12 months (or perhaps more) worth of emergency savings. Whatever length of time you choose, though, you can rationally determine a dollar amount by multiplying the cost of your basic monthly expenses times that period of time. That would be your minimum savings goal.
The second step is to ask yourself if that amount makes sense. For example, I once worked with a family, in which the father was a government employee with a secure income, and because the family had modest lifestyle goals, they had decided upon a relatively low goal for their emergency savings. However, upon further review, they realized that their costs could be much higher in the case of a family emergency, since the wife had family living overseas. So, adjust your savings goal upward if it makes sense to do so.
The third step, after incorporating objective and subjective emergency expenses, is to include known short-term goals, like vacations, new automobiles, child expenses, etc. These should be added to the unforeseen emergency expenses list, so that your savings plan is not wrecked when you return from your carefully planned vacation only to find a flooded basement.
Monthly contributions to savings. Now, if you’re doing everything right, your monthly contributions to savings may eventually cause your emergency savings goal to be exceeded, but don’t stop contributing to it. I have found that families who stop their monthly savings contributions and divert those dollars to other purposes are rarely able to reinstate the monthly savings amount when savings become depleted. You may determine that it’s okay to transfer some of these “excess emergency savings” to more fruitful ventures such as long-term investments, but do not stop the monthly savings contribution.
So where do we put our savings? Once you have determined how much you should have in savings and how much to set aside each month to reach your savings goal, the next obvious question is where to put it. Again, the answer is simple. Put it in the bank or credit union. At the bank, you’ll generally have the choice of using a checking account or a savings account—accounts which are highly liquid and very safe—but the rates of return are often very low or nothing.
Checking accounts are generally designed for high-activity cash management and are primarily used for day-to-day expenses. For most families, a savings account is going to be the preferred savings vehicle for maintaining your emergency and short-term savings. Various banks and credit unions have different names for different savings account products but by and large they will bear a slightly higher interest rate than a checking account. Talk to your bank or Financial Advisor about the various options available to you.
If you have a large emergency savings goal, and it is unlikely that the entire savings goal amount would ever have to be withdrawn at one time, it might make sense to put some portion of emergency savings into CDs. If there are multiple CDs used, it may also make sense to “layer” these CDs such that they mature at regular intervals, say every three or six months.
Used in combination with a comprehensive financial plan, “The 3 B’s of saving” can help you budget and prioritize your spending to assist you in your pursuit of a well-funded retirement.