Saving money for a big purchase can sometimes feel confusing. Most of us know that we should be saving money, especially when it comes to purchasing large items in the future. But how do we do it? Some people will tell you to invest your money, and others will tell you just to save it at your bank. I’m here to set the record straight and show you the proper way that you should be saving money when you want to buy something in the future.
CAVEAT ALERT:
In this article, I am going to talk about places to save money for future purchases, NOT for retirement.
Saving for retirement is in a different category. Saving for retirement is investing and should not be treated the same way as saving up to purchase something.
(1) Saving an Emergency Fund
An emergency fund is one of the most important parts of your personal finance journey.
Financial advisors can disagree on an entire host of issues (and often do), but the one thing that nearly all financial advisors agree on is the importance of an emergency fund.
An emergency fund needs to be three things:
- Liquid: Meaning that you can access it simply by moving money around in your online banking app, going to the bank or credit union and withdrawing money, or simply writing a check (not by using a credit card).
- Left alone: Meaning that you don’t touch that money unless it is an EMERGENCY. This is not money that you have put aside and decide to use because a new phone is on sale.
- Adequate size: I’ll get into more detail in this in a future article, but emergency funds need to be no less than 3 months of your living expenses. Meaning that if it costs $4,000 per month to pay your bills, buy groceries, get gas, etc. then you should have at least $12,000 in your emergency fund.
Emergency funds should be held in a savings account, money market account, etc. at your bank or credit union.
Yes, the interest rates suck at a bank or credit union. But there is a trade off with risk and reward in all investments and savings. With a savings account at your bank, there is virtually no risk and there is virtually no reward. And that’s okay!
The purpose of an emergency fund is to be there in the case of an emergency. You cannot afford to invest it and potentially lose some of your principal. Just put it in a savings account at your bank or credit union and let it sit there.
(2) Saving for Something in 12 Months or Less
If you are saving for something that you want to buy in less than a year or so, just do it in a savings account like your emergency fund.
But with one big difference: Do this in a savings account other than your emergency fund. You don’t want to get confused on what money is for an emergency and what money is there to purchase something in the future.
Most banks and credit unions will allow you to open as many savings accounts as you want. Have a separate account to save up for things that you want to buy in the near future (12 months or less).
Also, don’t get held up on the interest rate. Even the high yield savings accounts suck. If you want to go out of your way to open a high yield savings account, that’s fine. But don’t stress if you don’t want to.
(3) Saving for Something 1-5 Years Away
I know that I sound boring, but if you are saving money for something that is 1-5 years away, just put it into a savings account also.
But, like before, do this in a separate savings account from your emergency fund.
Some people will try to disagree with me on this one and say that you should invest your money that you are saving for something 3, 4, or 5 years from now.
But I completely disagree.
If you are saving for something that you want to purchase in the next few years it is probably really important. Maybe a wedding, a vehicle, a house, a business, etc.
You don’t want to risk that money going down in the market if your timing is bad.
In fact, if you were to invest your money for AT LEAST 5 years, you have an 87% chance that you will make money over that time. But if it is just a year, you only have a 73% chance of making money. I certainly like an 87% chance that I won’t lose money better than 73%.
You don’t want to risk the market going down just when you need to use the money and then you don’t have enough. No one wants that.
(4) Saving for Something More than 5 Years Away
If you are saving for something that you want to purchase in MORE than 5 years, you can invest it. Just be fairly conservative with that money. I would not invest it in anything more aggressive than an S&P 500 index fund or ETF. The fees will be low and you can essentially ride the market.
If you are saving for something that you want to purchase in more than 5 years you can afford to take some risk with that because you have time for the market to recover if there were to be a downturn.
If it is less than five years from now, don’t invest it. Just save it.
Final Thoughts
This might seem somewhat confusing. But with most banks and credit unions, you can open as many savings accounts as you want. Here is how I have mine set up:
Checking account- For all of my bills and debit card purchases, etc.
Savings Account #1- This is my emergency fund. I don’t touch it except for emergencies.
Savings Account #2- This is my short term savings account for things that I want to purchase in the next few months or so.
Savings Account #3- This is for my more long term savings goals. A new car, a big vacation, a special trip, etc.
It is a lot easier (IMO) to have separate accounts like this so that you don’t have to worry about taking too much/little money out of the wrong account.
After I moved to this model of having multiple savings accounts, my financial life became a lot easier. I could log onto my online banking app and see exactly how much I had in each account for each purpose.
You can do this!
I am here to help you in any way I can!
Until next time!
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