Interested in dialing down your financial stress and making your finances run more smoothly? Open and maintain two savings accounts.
Savings Account Number One: An Emergency Fund
During the early days of the recession, I worked with the market research firm Synovate to conduct a national survey (See “Tough Times Call for…”) asking people how much financial stress they were experiencing. We also asked about three details of their financial lives: whether they pay their credit card bills in full each month, whether they use a budget, and how much money they have in an emergency fund.
While all three money management practices are important, the people experiencing the lowest levels of stress were the 18 percent who had six months’ worth of living expenses set aside for emergencies.
How to Set Up an Emergency Fund
I don’t like the idea of keeping emergency fund money in your checking account. What I’ve found is that when you do that, the money leaks. It gets used for other things.
Set up a separate savings account that you keep stocked with money that is only to be used in case of emergency. And keep in mind that emergencies do not include the need or an oil change or new tires. Those expenses should be covered by a monthly budgeted amount allocated for vehicle maintenance (more on that in a minute). Examples of true financial emergencies include the loss of your job or catastrophic medical bills not covered by insurance.
I used to recommend that people keep three to six months’ worth of essential living expenses in an emergency fund. However, the recession has changed my mind. Now, I believe we should all keep at least six months’ worth of living expenses in an emergency fund
Sounds Easy, But…
As I wrote that last sentence, I could hear people asking the question Steve Martin asked in the hilarious Saturday Night Live skit, Don’t Buy Stuff You Cannot Afford: “And where would you get this saved money?”
If you will receive an income tax refund this year, use it to jump-start or build your emergency fund. Still need more money? Set up an automatic transfer from checking to your emergency fund savings account. Start small, if you have to, but start the process of automatically stocking this savings account.
If you’re investing for retirement but don’t have an adequate emergency fund, I recommend that you redirect most or all of the money you’re investing each month toward your emergency fund. Then, once your emergency fund has six months’ worth of essential expenses, go back to investing.
Good places to set up an emergency fund include a bank or credit union savings or money market account. You won’t earn much interest from such accounts, but the money will be safe and relatively easy to access if and when you need it. Those are the key benefits you need from an emergency fund.
Savings Account Number Two: For Periodic Bills and Expenses
A periodic bill or expense is anything you pay for at some point every year but not every month. Examples include semi-annual property tax and car insurance bills, an annual life insurance bill, vacations, gifts, and maintenance for your home and car.
Such bills and expenses can be budget killers if you aren’t planning ahead. However, by taking one-twelfth of the annual cost of all such bills and expenses and automatically transferring that amount into a separate savings account each month, the money will be there when you need to pay those bills and expenses.
For some periodic bills, like home owner’s insurance, vehicle insurance, and property taxes, take a look at past bills to see how much you spend on them each year and then divide by twelve. For others, like home and vehicle maintenance, take a look at my Recommended Spending Guidelines to see how much to allocate each month.
Then, take the total monthly cost of all such bills and expenses and set up an automatic monthly transfer from your checking account to this separate savings account. Then, just transfer money back to checking to pay the bill. Or, with some savings accounts, you can pay the bill directly out of that account.
Just as with an emergency fund savings account, good options for this second savings account include bank or credit union savings or money market accounts.
Using a separate savings account for periodic bills and expenses is one of the most beneficial changes we’ve made in our household over the past five years. We used to just let the budgeted amounts for such things build up in our checking account, but there’s something very reassuring about setting money aside each month in a separate account for big bills that we know are looming on the horizon.
What are your thoughts on the idea of using two savings accounts?
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