Three Tools for Building Savings
By Christine Schmidt
In the previous article, savings was encouraged as a necessary way of living out monetary stewardship. This article focuses on three simple ways to accomplish building up money for this purpose: a frame of mind, a description of various accounts, and a misunderstood and underutilized tactic, debt. With an awareness of these three tips and tricks, one may find it easier to accomplish building savings that allows them to be prepared for emergencies and accomplish short-term goals and needs.
Saving more by knowing less
To help build a saving habit, the approach “out of sight, out of mind” is generally a good tip. While it may appear as counterintuitive to stewardship, checking our savings less, especially the subcategory emergency savings, is both compatible and beneficial. What is meant by the financial approach out of sight and out of mind is to avoid checking or looking at savings accounts frequently. While it is good to check it every once in a while, say monthly, we do not want to rely on the account as a supplement to monthly income or as something to be used for just any situation.
Once we stop frequently checking our savings accounts, we stop rationalizing that there is enough for unnecessary expenses––and this helps us to avoid the temptation to overspend or use the funds for another reason besides for why the account was made in the first place. When the budget was created, flexible expenses such as entertainment and groceries were already factored in, therefore keeping too close of tabs on savings accounts can mean we are able to persuade ourselves to overspend what was already budgeted. Additionally, checking the account less frequently means that we tend to forget about it as a normal account to use––and the less it is used, the more money it accumulates over time.
Of the two subcategories, looking at the emergency account less frequently is more important because we want to be assured that our emergency money is always there when needed, and avoid unnecessary debt since we have already saved for emergencies instead of having to borrow or use credit cards for such situations. Short-term savings is much more fluid, and used for things more frequently, so looking at the short-term savings account is preferable to constantly viewing the emergency savings account. One way to assure the money saved for emergencies is left alone is to place it in a separate banking account from short-term savings
Knowing where to build your savings
There are several ways to save money utilizing different kinds of financial accounts with different benefits; among them are savings, checking, money market, and certificate of deposit accounts. Where these accounts typically differ is the interest earned on the money saved in the bank or institution. Here, interest is the money an institution pays you for keeping your money with them. Below, I’ll review the differences between these accounts and the unique features of each:
Savings accounts: Like most savings available accounts, this account is extremely liquid. Currently, savings accounts will pay out one to five percent interest depending on the bank.
Checking accounts: Similar to savings accounts, checking accounts are incredibly liquid. One benefit is that they can be connected to a bank’s credit cards, making it easy to pay the balance while allowing for some security if there is a breach and someone uses your card without your knowledge. Checking accounts, however, typically offer lower rates of interest, on average a thirtieth of a percent.
Money markets: Money markets are, you guessed it, very liquid. Unlike savings and checking accounts, money markets are only offered by some banks or institutions, but they offer a unique benefit of a higher interest rate on their accounts. One thing to note is that there may be restrictions on how much money needs to be kept in the account perpetually for a money market savings account. The restrictions on how much money needs to be in a money market account to be accessible for savings can mean that it may be an unavailable or illogical option. Money markets may be more useful to those who have an already established savings or who have the ability to set aside a larger amount of money for savings each month.
Certificates of deposit: Lastly, certificates of deposit, or CDs are a specialized kind of savings. There are federal laws which require institutions to keep a certain amount of funds in the bank at all times, which is calculated on how much money is being stored in the institution. CDs are a way that institutions incentivize customers to keep their money in the institution for a higher interest rate than a typical savings or checking account––as long as the client does not withdraw the money for a specified period of time, usually ranging anywhere from three months to around three years. While it is not advisable to use a CD for an emergency, if there is a particular goal in mind that will happen in the near future, a CD may be a good way to earn some extra cash as you wait for the time to pass to accomplish that goal!
Based on when you need the funds, as well as what you are using the account for, it is important to match the appropriate tool to the right goal. Any of these accounts can be found at banks or credit unions. The difference between these two institutions is that credit unions tend to be smaller and more localized and can offer higher interest rates, while banks are more nationally recognized but offer lower interest rates.
Debt: An underutilized tool
One misunderstood and underutilized tool is debt. While it seems bizarre to see debt positively talked about in a financial article focused on savings, debt––understood properly––can be a creative and smart way to allow for greater cash flow by putting your money where it will work hardest for you.
Debt, simply defined, is borrowing someone else’s money for a purchase. Many young people have experienced this with student loans for college education or with purchasing a vehicle. While many have been exposed to debt, few have been educated on why one could use debt as a tool and how to discern when it is beneficial versus detrimental.
It’s important to understand when it is a good idea to use someone else’s money. There are two major indicators to help in discerning when debt is the right tool to use:
Do you gain significant benefit from debt?: This indicator is more subjective. A quick test, however, lies in determining the need for the purchase. How great is the need? Can you live without the purchase for some time and be fine? Being honest with your wants and needs, as discussed last month, is critical. Some items that may necessitate the use of debt could include tires or a heating and cooling unit when they are in disrepair and no emergency savings has been established. The need is urgent and the tools that would normally assist in managing these emergencies is unavailable. New furniture for a room would be something that is less urgent, something that short-term savings is better used towards.
Is the money better utilized elsewhere?: This can be tested by looking at the timeframe and the interest rates. While some items are assuredly needed as an emergency item, others are better classified as wants or short-term needs. These items may be purchased now or later. The timeframe is essential when determining this since, typically, the alternate tool to savings is investing (more in next month’s article). Savings may have a low amount of growth while investments typically tend to return at higher rates. The longer you have to wait, the longer your money has to lose or gain purchasing value. Additionally, it is important to remember that investment types of accounts are more efficient when the goal is more long-term (five or more years away).
This is why interest rates are important to consider as well. When laying out the different savings accounts available, we mentioned how the bank or credit union may pay interest to you for keeping your money in its institution. Debt works in the opposite manner––when borrowing someone else’s money you pay them interest for lending it to you.
If you can get a loan with a low interest rate, don’t stress about paying it off immediately. It may mean that it would be better to utilize your money in an investment account (like money markets or high-interest savings or mutual funds) and use a portion of that growth to pay back the loan over time; this allows you to keep the difference between the payments on your loan and the growth from the money market for other uses. By putting your money in a higher interest account, you’re simultaneously able to repay the debt as well as save for other goals.
An essential thing to note with interest rates is that you should always avoid high-interest debt because it can put you in a more difficult situation when it comes to paying it off. By using high-interest debt, one could potentially pay double or triple the original cost of the item or service bought. This can trap the user in a cycle by overutilizing debt since one was not able to build an adequate amount of savings which mitigates the use of debt. Furthermore, and more dangerous, once you have more than a third of your income going towards debts it can also be detrimental in attaining other important financial tools, including home loans, consolidation loans that can reduce interest on loans, and even bank accounts.
Using high-interest debt for wants is what drives the misconception that debt is always a bad thing. In reality, debt may be used well but it’s important to be prudent when discerning whether or not to utilize debt as a tool. Thus, it is better to consider using debt as an instrument in your plan when the interest rate for what you owe is lower than the rate of interest you could get in an alternate account.
In sum, there are many simple ways to build and understand how to make sure you are able to save for your needs, wants, and goals for the future. You may utilize different psychological tactics, different accounts, or even debt. Whether you use one or all these tips, approaching savings with confidence and knowledge can help you better prepare for the future and build your savings.
