During an enjoyable dinner with my wife and some good friends the other night, I glanced beyond our dining room through the windows in our kitchen and was surprised to see the sky turning ominously dark. It had been a beautiful day, but very suddenly the weather changed.
That’s how life is, isn’t it? Things can change quickly, which is why we need to be prepared for the various financial storms that come our way. The best way to prepare is to build three types of savings.
1 – Emergency savings
For as long as there have been personal finance surveys, there have been warnings that too few of us have a rainy day fund. Here’s the latest: According to Bankrate.com’s 2014 Financial Security Index, 50% of U.S. households have less than three months’ worth of expenses set aside in savings.
Despite various writers’ attempts at making this story more creative, edgy, or interesting, the same boring advice that’s been doled out for years still holds true: Most households should have three-to-six months’ worth of essential living expenses in reserve. Hitting this target protects against the possibility of a job loss and adds peace of mind.
2 – Savings for periodic bills and expenses
Most of us have expenses or bills that come due sometime during the year, but not necessarily every month — an annual life insurance premium, semi-annual vehicle insurance bills, and Christmas gifts to name three. Totaling up the annual costs of all such items, dividing by 12, and then automatically transferring that amount from checking to a separate savings account each month can do wonders for your cash flow.
My guess is that relatively few people have such an account.
3 – Savings to replace big-ticket items
This is likely the most neglected form of savings.
Think of all the big-ticket items you own that will one-day need to be replaced: vehicles, appliances, your roof, an air conditioning unit or furnace.
This is an important type of savings for those of us who are gainfully employed, and it’s especially important for those who are retired. MarketWatch emphasized this point in an article about what retirement calculators typically don’t include: provision for large future purchases.
Reserves have a huge influence on your plans for future retirement spending. A retirement plan can never be perfect, but failure to make a quantitative financial plan accounting for reserves will almost always lead to a debt burdened retirement.We should take a lesson from the many organizations that plan for big-ticket item replacement as part of their standard operating procedures.
The military uses the statistical concept of mean-time-between-failures (MTBF) because it deals with large numbers of things that wear out. Businesses use the concept of depreciation. Large condominium and timeshare projects plan on the lifetime of specific things.
I’ve always found it best to keep these three types of savings in separate accounts. An account with co-mingled money tends to leak.
How well have you done with building these three distinct types of savings?