Different kinds of accounts where you can keep your money … and how to use them. This is the way I do it.
Checking account (for day-to-day expenses). Even if it’s only used to fund ATM withdraws, debit-card purchases, and online bill paying, everyone should have a “checking account” — despite the fact that many people don’t even have blank checks these days, Indeed, the last time I purchased blank checks I probably got enough to last the rest of my life. A checking account is for your usual day-to-day bills. It should have enough money to cover transfers to your savings account (pay yourself first) as well as your regular monthly expenses, such as the rent or mortgage payment, and bills for utilities, groceries, transportation, and other things that you pay for daily, weekly, or monthly. Whatever comes out of your checking account should be replenished by income coming in. (Did you see the post about how the money in your checking account is like a tank of water?)
In addition to your checking account for expenses that come due every month or more frequently, you should also have separate accounts for expenses that come less often.
The first three, like the checking account, should be at a credit union or bank.
- Emergency savings (unexpected expenses). Everyone should have money set aside for emergencies, those unfortunate unforeseeable expenses: accidents, medical problems, periods of unemployment.
- Short-term savings (once-or-twice-per-year expenses). Money set aside for foreseeable and predictable expenses that come once or twice per year, such as property tax and homeowner’s insurance payments, and expenses for birthdays, holidays, and vacations. At my credit union I have a “Holiday Club” account that automatically takes $83 (or any amount I choose) from my checking account each month and deposits it into the Holiday Club account. Then at the at the end of November, the accumulated sum is automatically moved back into my checking account. It’s a pleasant surprise to get $1,000 just in time for Christmas.
- Medium-term savings (once every few years or just a few times per lifetime). Money for foreseeable, but perhaps not predictable, expenses that come less often than yearly, such as purchases and/or repairs of automobiles, refrigerators, heating and air conditioning systems, washers and dryers, and major household expenses such as a new roof. Other medium-term savings goals might include medical or dental procedures; weddings and funerals; house purchases, remodeling or additions; college educations, starting a business, or moving to a new house. It’s also good to have ready cash for unexpected opportunities such as great deals at a going-out-of-business sale or a used car at an especially good price.
The last one should be with a mutual fund company so the money can be invested in stocks.
- Long-term savings (once in a life). For foreseeable expenses that come just once in your life, such as buying your dream house and retirement. Basically, your 401-K, IRA, and similar.
How much should you put into these savings accounts each month?
There’s no definitive answer.
Let’s start* with at least 10% to 15% of your total household income going into your retirement savings. After that, maybe an additional 1% to 5% of your income distributed among the short-term, medium-term and emergency savings accounts? There are many factors to consider: How large is your family? Are your kids going to need braces? Can they get scholarships for college? How handy are you when it comes to doing home repairs? Do you need to buy new cars or can you be content with “pre-owned” cars? How much will your home addition or dream house cost?
Your goals should be something in the order of at least $1,000 dollars each in emergency savings and short-term savings and perhaps several thousand dollars (or perhaps much more) in your medium-term savings account.
You might want to think of it in terms of your income:
- Emergency savings. Equal to at least 3% of your annual income or $1,000 to $2,000 (whichever is higher).
- Short-term savings. At least 3% of your annual income or $1,000 to $2,000 (whichever is higher).
- Medium-term savings. At least 10% to 50% of your annual income.
- Long-term savings. 25 times your annual income (when you reach retirement age). In other words, millions.
There are many experts who say your emergency saving account should have 3 to 6 months of living expenses (all the normal food, shelter, and transportation expenses). This might be around 30% to 40% of your annual income. One of the reasons for this amount is to maintain your household during periods of unemployment. If you think of unemployment of an “emergency” then your emergency account should be correspondingly larger. Alternatively, you could view your medium-term savings as your unemployment reserve. How likely you are to experience a period of unemployment is also a consideration.
* This assumes you have no debt other than a mortgage.