Beyond a Budget: Savings
by Gary Foreman
Congratulations! Last year for the first time you actually ended the year knowing how much you made, how much you spent and where all the money went. Some of you used fancy software and tracked every penny. Others got buy with a few sheets of notebook paper and only tracked the larger items. But the point is that it worked. You now have some data that can tell you quite a bit about your financial situation.
Here's a question that you'll now be able to answer. Did you save any money last year? If you did it could show up in a couple of different ways. First, compare your income and expenses. If you spent less than you made you saved money during the year.
Savings can also be found masquerading as an expense. Did you have payroll deductions going to a 401k retirement account? Perhaps you were making contributions to your IRA. What about prepayments to your mortgage or auto loans?
Let's take a closer look at savings. What are savings anyway? One of the definitions in the American Heritage dictionary is "preserving or rescuing". They mean that something has been saved from destruction. But, really, a savings program can rescue us from future financial needs. For our purpose let's define savings as money that has been set aside to grow for future use.
Now let's ask "why save money?" And it's a good question. Do we do it because it's a nice thing to do? No, we do it to pay bills that we expect to occur later. Some will be relatively unexpected like a auto repair or accident. I say relatively unexpected because even though we don't know when they will occur, we can be reasonably certain that at some time they will happen. Another reason to save is for expected future needs. Things like college tuition, retirement or a down payment for a home.
All these needs have something in common. We can estimate how much we'll need and when we'll need it. Take the unexpected. Experts will tell you to keep an amount equal to three months of your expenses available. Since we can't say when we'll need the money, it's wise to keep it where it's always available.
What about the planned expenses? Well, you'll need to do a little research to figure out how much you'll need and when you'll need it. It's outside the scope of this article, but suffice it to say that it's possible to say that you'll need about $80,000 for Junior's college education beginning in the year 2013.
Next, let's look at how and where to save money. Begin with your budget. Are you already putting money into investment programs or generating a surplus to expenses? If so, great! If not, you'll need to take a look at those expenses and see where you can find some money. For most people the first place to look in the area of food and groceries. If that doesn't work you might need to consider making a change that would shave expenses in transportation or housing. Perhaps you'll save a little here and a little there.
So now that we've found some extra money where do we go with it? Ask yourself a question. Would you solve a problem that occurred today or one that will happen ten years from now? You'll solve today's challenge first. It's the same with our savings program. Our first concern is to have money available for those 'unexpected' requirements.
We said that we wanted that money to be readily available. Today or tomorrow if necessary. So wherever we put our savings must be very safe and accessible. That limits us to a very few choices for our savings. We basically want something that will allow us to go get our money or write a check on the account. We also want to know that our savings haven't lost value due to market fluctuations. In short, we want our money to be ready for us anytime.
There are only a few places that can do that for you. Your bank or saving and loan association will offer different savings accounts or money market funds. Likewise your local credit union if you're eligible for one. You'll have a couple of choices for accounts that guarantee the safety of your savings and ready access to the money. Typically savings and money market accounts. You may be offered certificates of deposit (CD's). Remember, that you'll lose interest or pay a penalty if you take the money before it's due. Considering the likelihood of needing some of that money over any six or twelve month period, CD's are probably not a good choice.
You may also want to consider money market funds offered by the mutual fund companies. Typically these are offered without commission to you and may pay a little higher interest rate than the bank money funds. You'll need to find one that will allow you to write checks against your account. You'll also need to remember that if you should need to deposit that check with your bank it will take a few days to clear.
OK, so now we've decided how much we need in our saving/emergency account. We've found a source of savings to feed the account. And we've decided where we're going to stash the savings. How long will it take us to accumulate our goal? That's a simple matter of mathematics. We said that we wanted an emergency fund that was equal to about three months of our expenses. That's 25% of our annual expenses. If we're saving 10% of our expenses (which isn't a bad target), it'll take two and a half years to accumulate the fund. The interest on the savings account will shorten the period by just a little. You're probably saying 'that's a long time'. And yes, it is. All the greater reason to start now.
What happens if you need some of the money before you manage to reach your savings goal? Use it! That's what it's there for. Just remember that the fund is for unexpected expenses. If you need to buy new tires once a year that should come from your regular budget, not from your savings. There's a temptation to pay for larger expected bills from your savings fund. Don't fall for it. You'll only deplete the fund and increase your risk of failure.
Establishing a savings fund will improve your life in a number of ways. You won't need to worry that an unexpected bill will upset your budget. You won't be financing the next 'surprise' on your credit card at 18% interest. You'll have crossed a very important line. You'll be earning interest rather than paying it. And you'll also be moving towards accomplishing your bigger financial goals: buying a house, college education and retirement. But that's the subject for a future column!
It's up to you. The road to financial freedom isn't a mystery. It's a matter of learning what to do and having the discipline to do it. What about you? Do you have what it takes to control your own financial destiny? Great! Then go get started...
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Gary Foreman is a former financial planner and purchasing manager who founded The Dollar Stretcher.com website and newsletters in 1996. He's been featured in MSN Money, Yahoo Finance, Fox Business, The Nightly Business Report, US News Money and CreditCards.com. Gary shares his philosophy of money here. You can follow Gary on Twitter or visit Gary Foreman on Google+. Gary is also available for audio, video or print interviews. For more info see his media page.
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