Three Categories of Savings – Edited

There are three primary kinds of savings, each with multiple flavors and ways to save.  They are:

  1. Emergency Savings
  2. Replacement Savings
  3. Long-Term Savings

Savings should be put aside in this order.

Emergency Savings

Emergency savings prepare you for the unexpected. What if you were to lose your job tomorrow?  Or you were to be injured in an accident and encounter major medical expenses?  An Emergency savings fund can be the difference between piling up significant debt in these situations and making it through without endangering your spending plan.

An Emergency Savings fund should have at least three months of basic living expenses (such as housing, food, and transportation costs).  This should be sufficient to cover most unforeseen emergencies like the ones above.  Emergency savings should be kept in accounts you have easy access to (like a money market fund), so that you can access them quickly should a need arise.

Replacement Savings

Replacement savings enable you to make large, planned purchases without increasing debt.  For example, appliances all break down sooner or later.  Planning for these events and putting aside replacement savings in preparation not only protects you from going into debt, but also significantly relieves the stress of these situations.  If you haven’t built up the replacement fund before an item breaks, you can use emergency savings for the replacement if the item is truly an emergency.  For example, a refrigerator may be a necessity in most circumstances, but a dishwasher rarely would be (most people can wash dishes by hand for a time while saving up for the replacement).

How much is enough for a replacement savings fund?  This will vary by individual and family.  Think of the things you can anticipate replacing someday, such as appliances, furniture items, or maybe a car.  What would it take to replace the most expensive one without incurring debt?  Start there.  And don’t assume you have to replace like-for-like.  Maybe the expensive SUV purchased several years ago can be replaced by a dependable used car.  These are all individual decisions – just consider your options.

Replacement savings can be invested in instruments such as short-term CDs.  See www.bankrate.com for funds with the highest return rates. Because these are for planned purchases, you don’t need the money to be quite as “liquid” (available quickly) as Emergency savings.  But you also don’t want the funds tied up in long-term instruments so that they’re not available for purchases when you need them.

Tip:  Have emergency and replacement funds direct-deposited into your savings accounts – it’s all too easy to spend the money when it’s in your checking account!

Long-Term Savings

Once you have sufficient emergency savings and replacement savings in place, it’s important to think about long-term savings.  Long-term savings prepare you for events like retirement and children going to college.   Being prepared for these events is literally a life-altering provision.

How much is enough for Long-term savings?  The answer to this question varies widely, more so than either Emergency or Replacement savings.  Planning for the future is an important and wise aspect of stewardship; however, beware of the danger of placing your faith in material wealth for the future.

Tips for retirement savings:

  • Take advantage of your employer’s retirement plan if available, especially if they provide matching funds
  • Consider other tax-sheltered investments, such as IRAs
  • Don’t borrow from retirement accounts!  For more information on the dangers of borrowing from retirement accounts, see p. 108 in the Appendix.