Saving money can mean different things to different people. Some of us are inclined to save for a rainy day. Perhaps you have 3-6 months of monthly expenses already set aside, but maybe your retirement savings is lacking. Today let’s look at why people save and what are the top 4 savings accounts one should have to set themselves up for success.
1) Emergency fund
An emergency fund is 3-6 months of living expenses in that “just in case” scenario. What if you suddenly lost your job and were not qualified for unemployment benefits? What if you had an unforeseen expense such as an insurance deductible, or an automobile repair? These are things that could be covered with an emergency fund.
2) Retirement savings
Retirement savings can come in the form of a 401(k), IRA, 403(b), etc. The idea here is pretty self explanatory — let’s use this account to fund our eventual retirement and have enough set aside to draw income from in our later years. This fund will be used to supplement other types of retirement income such as social security, a pension, etc.
3) The "Next 5 Years" fund
What do you want to do in the next 5 years that will require a chunk of change? Will you need a new vehicle? Home repair? New roof? Is there a vacation you’ve had on your radar? What about a child’s wedding, or a graduation party? These are the things that can add up. We’d encourage you to think about anything that will cost over $500, and set this aside in your “next 5 years” account.
4) The annual fee fund
These are the things you are supposed to earmark throughout the year but, let's face it, you probably don't. Examples include annual credit card fees, Amazon Prime subscription, insurance policies. Heck, even holiday gifts can go in here. This is different than your emergency fund because these are things you know are coming up, so if you set aside money in a separate fund, it makes paying for them more painless when the money is out of site, out of mind.
Do these 4 funds need to be separate bank accounts?
It depends on how you operate. Some people need the money to be out of site, out of mind. Others are able to view the money in the bank and know that the number shown in the account is not indicative of the true value as the money has been ear-marked. There's a psychological factor here. We might be more inclined to spend money when the account balance looks larger than it actually is.
If you use the ear-mark method, be sure to keep an ongoing spreadsheet so you can track what the actual figure is in your account for covering monthly ongoing expenses.