This is a guest post from Sarne – Frugalbeans.com discussing savings.
Regularly contributing to savings in any form is an integral part of most people’s budgets nowadays. However, with many types of savings accounts, funds, investment accounts, early debt payoffs and scrimping it can be confusing on what to do with the money you budget to ‘save’.
What Is Considered As ‘Savings’
Investopedia.com defines it as:
Savings refers to the money that a person has left over after they subtract out their consumer spending from their disposable income over a given time period. Savings, therefore, represents a net surplus of funds for an individual or household after all expenses and obligations have been paid.
How you budget and your income will determine how much percentage of your income you can save. For example, following a budget style of 50/30/20 (50% needs, 30% savings, 20% wants) allows you to contribute 20% of your disposable income towards savings.
The financial independence community aims to increase their savings rate to as high as possible to reach independence. Although for most of us we strive to attain a comfortable rate of savings to retain an enjoyable lifestyle alongside a savings ‘buffer’.
Deciding which type of budget to follow depends on a couple things. Your needs, wants, lifestyle and financial goals.
Here is Fernando’s 2021 budget as an example.
Traditional Transaction/Savings Accounts
The most common savings for many of us is the humble savings account. A set and forget account. A place for money to go and stay. However, the traditional savings account does not do anything for growth. In fact, when you factor in the average rate of inflation a traditional savings account actually loses money over time.
High Interest Savings Account
High interest savings accounts are accounts that offer competitive interest rates that help your money grow. Just by having your money sit there it will grow by however much the predetermined interest rate is. Although most financial institutions that offer these accounts have a variable rate, meaning the rate could go both up or down.
Funds (Emergency, Sinking)
Emergency funds and Sinking funds are both types of savings categories that serve different purposes albeit similar goals. They both aim to give you comfort and stability in your financial situation.
Emergency Funds are exactly that. Funds put away for only emergencies. Unexpected expenses that would otherwise throw your entire budget out. Funerals, Hospital emergencies, illness, broken down cars etc. The emergency fund acts as a safety net for unexpected expenses. How much you hold in the fund is entirely up to you. Some financial independence followers suggest 3 months living expenses however making a start is what’s most important.
Sinking Funds on the other hand are set up for upcoming ‘expected’ expenses. Birthdays, Christmas, Car registration or any other expenses that you are aware of are coming up.
Emergency Funds are there for what comes unexpected whilst a Sinking Fund is set up for planned expenses.
Early Debt Payoff
Paying off personal debts has big advantages long term including reducing the amount of interest paid as well as clearing the principal owed. Understanding debt is also an important part of how to pay it off sooner.
Contributing extra to a personal debt like a loan will reduce the amount of interest paid and decrease the principal amount directly.
Paying off debt early puts you in a stronger financial position to contribute to aspects of your life that provide much more value to you. Eg. savings accounts. However, everyone’s circumstances are different. To decide what’s best in your case, evaluate how you benefit from having debt, and weigh up those benefits against the cost of keeping debt.
An investment can be considered as anything that you put your money in and get that money back with growth/interest and/or returns however for the purpose of this article we are referring to investing in the stock market. Investing can be confusing, to start off it is best to do your research thoroughly.
Warren Buffet defines investing as ‘the process of laying out money now to receive more money in the future’.
- Investing is defined as the act of committing money or capital to an endeavor with the expectation of obtaining an additional income or profit.
- Unlike consuming, investing earmarks money for the future, hoping that it will grow over time.
- Investing, however, also comes with the risk of losses.
- Investing in the stock market is the most common way for beginners to gain investment experience.
Having any savings is better than none but once you understand the purpose of your savings, you are then able to take advantage of that and have them grow.
Whether that be through a high interest savings account or investments. Although investments come with added risk of losses there is tons of educational content available about investing in lower risk things like exchange traded funds.
A huge thank you to Fernando for featuring this article. If you would like to see how I split up my savings click here.