Most people understand what a “budget” is. While accountants might use the term a bit differently, in personal finance like I teach, it’s simply a spending plan for your income.
Now, a lot of people struggle with translating that into practical action to improve their financial situation by actually creating and living on a budget. But generally they at least see the reason for it:
Planning your spending prevents overspending.
But you’d be surprised at how many people don’t apply that same principle to their saving. I don’t mean that they don’t save...many if not all are doing a budget of some sort and if they’re out of debt, they’re directing money towards saving.
The trouble is that I often find that people don’t know WHY they’re saving. When that happens, they end up OVERSAVING.
Yes, just as having a spending plan prevents overspending, planning your saving prevents oversaving.
I know of a couple who had so much money saved up that (once I pointed it out) they were able to pay off their two rental properties in one fell swoop, just by thinking about the purpose for their savings, and calculating what they actually needed for specific purposes.
I know of another couple who had an extra $20,000, (beyond their emergency fund and home improvement fund) just sitting there with no designated purpose, that they could put on their mortgage when they refinanced, thereby reducing both their balance and their interest rate.
You need a spending plan, but you also need a saving plan.
There’s no such thing as saving without a purpose in mind. Well, at least there shouldn’t be.
So what are the possible purposes of saving?
1. First and foremost, for an emergency fund. The purpose of an emergency fund is to keep you from going into debt, when...
The emergency is a large, unexpected, and necessary purchase....like a major car repair, a family funeral in a distant city, or a new furnace in the dead of winter.
The emergency is a loss of income, due to job loss, or maybe loss of a tenant in a rental property.
(If you have debt other than your home mortgage, then limit your saving to a $1000 baby emergency fund for now, and focus intensely on getting out of debt. See my website for more information on that if you need it.)
2. Second, a sinking fund. This is the one thing that every client of mine remarks on that made a huge difference in their finances.
A sinking fund is where you save on a regular monthly basis for those big bills that you can somewhat predict as to timing and amount, that would otherwise totally crash your budget if you didn’t have the money saved up.
tires for your car,
big insurance or tax bills,
3. Third, major home improvements. This is an area that SOOO many people seem to go into debt for. And that’s nearly always just a desire for instant gratification.
Instead, find joy in the planning process. And while you’re planning, save up the money.
4. Fourth, your next car. And note I didn’t say NEW car, just next car. (If you have a million dollar net worth, then go ahead and buy new if you want. )
Pleeeaassseee stop saying things like “You’re alllllways gonna have a carrrrr payment.” Yes you should hear that in an exaggerated, mournful voice. Because it's a very sad falsehood.
5. Fifth, your next home. Which might be your first home. I'm talking about a healthy down payment of 20%. But of course, I love the 100% down plan too.
Beyond those five things, you should be INVESTING, not saving.
What's the difference between saving and investing?
Saving means keeping the money fairly liquid (accessible quickly and without penalty). In exchange for that, your interest rate or return will be lower. But there is far less chance of losing the money, so you can be sure to have it when you need it. Saving is for when the purpose for the money will occur in less than about 5 years.
Investing is for the longer term, and in order to get a higher return or interest rate, you give up the ability to access the money quickly, or you risk losing money by having to cash it in during a down market when you need it.
Your investing should also have a purpose. So purposefully invest in...
Your retirement accounts, so you can retire with dignity at an age where you’re still young enough to enjoy it. Investing 15% of your income will do that.
Your children’s 529 education saving accounts, so that they don’t start their adult life crippled with student loan debt.
Your home, by paying extra principal on your mortgage to pay it off as fast as possible, which frees up your income for other purposes.
Your community, by becoming an outrageously generous giver.
So what are YOU saving for? If you want to brainstorm some ideas, schedule a complimentary consultation with me here.