Imagine waking up one day and seeing the sky through a hole in your roof. Or think about what you would do if some knucklehead wrecks your car on the way home from work. Can you write a check without worrying about going into debt or seriously digging into your savings?
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We all know that we are supposed to save money for a variety of future needs like emergencies, retirement or big-ticket items. What is not mentioned is how to go about doing this. Creating a budget spreadsheet and earmarking your savings to specific categories is an easy way to make sure you are meeting your savings needs and goals.
Earmarks Are Not Bad
The word "earmark" may have a bad reputation because of the shenanigans that go on in Washington, D.C., but the principle is not nearly so bad. An earmark is simply a provision requiring that a certain percentage or amount of funds to be devoted to a specific project. In terms of a personal budget, an earmark is simply a way of making sure that you designate certain areas for savings (retirement, emergency funds, etc.) and tracking your progress. (For the other side of the coin, check out our article 6 Outrageous Political Earmarks.)
Many people save simply by sweeping whatever money is left over at the end of the month into stocks, mutual funds, savings or just rolling it over in their checking account to the next month. Even if you have the discipline not to overspend, this is a haphazard way to save.
In other cases, people simply do not think about what may happen in their financial lives. Most people know that they will retire someday and most people know that they need some funds on hand for a "rainy day". But how many people think about how many more years they can get out of their roof? Or realize that owning certain pets means they are all but guaranteed to have to shell out for major veterinary expenses at some point?
Earmarking can help you think systematically about the sorts of bills that could come your way, and how big they might be. After all, it is one thing to go into debt voluntarily (say, to buy a house). It is an altogether different situation to find yourself relying on credit cards or financing charges to pay for an expense that seemingly came out of the blue. (For more on budgeting, check out 3 Alternative Budgeting Styles: Which One Suits You?)
How to Start
The first step in earmarking your savings is to create a simple spreadsheet where you list the major categories of savings that you require. Almost everyone should have categories dedicated to emergency savings and retirement, and homeowners should have a category for capital repairs, and renters may want to consider a category for accumulating a down payment. Other categories could include items like your next car, a recreational vehicle or any other potentially large future expense.
Next, determine how much you need. There is a range of advice on what people should set aside as emergency expenses, with guidelines ranging from three months to 12 months' salary. Alternatively, you can estimate your normal expenditures in a month and then establish a goal based on those expenses, whether it is six months, nine months, etc. There is no "right" amount, but you should consider the nature of your work, whether your spouse works and how long you could be out of work if something happened.
If you are saving for a new car, get an estimate of that car's price today and factor in a few years of price increases. If you are saving for capital repairs to your house, you can estimate the cost of depreciation and set aside an amount that matches this.
Once you have a sense of the totals, establish how much to set aside each month. When you are just starting out, you will probably be behind a bit, so set reasonable goals and priorities. Building an emergency fund, saving for retirement and paying off high-interest debts should be the biggest priorities, but if it takes you a few years to get caught up on saving for a new car or capital repairs, don't worry.
Establish a monthly amount that you wish to set aside for each item. If you find that the amount you are supposed to save each month exceeds what is left after you pay all of your bills, adjust the targeted savings amounts accordingly and/or consider reducing your expenses.
At the end of the spreadsheet, you should have two summary columns - how much you estimate you need to have in savings, and how much you actually have. (Learn more in 6 Months To A Better Budget.)
Once you know what you are supposed to be saving, you need to find a place to keep that money.
Since emergency funds really must be there when you need them, it makes sense to keep these in very safe places - high-interest online savings accounts (FDIC insured) and CDs are good places for these funds. You will not earn much on this money, and you will likely lose ground to inflation, but consider that the price of extra piece of mind.
Other earmarks do not have to be invested quite so conservatively. Putting savings earmarked for house repairs or a new car can certainly be put into a savings account, but a high-quality bond mutual fund could provide a little more growth for a bit more risk. For something that really is not essential - like a vacation - even more risk could be appropriate, and that cash could be put into the market.
A Little Maintenance for Better Security
Creating special earmarks in your budget and savings is a painless way to save in a more organized and disciplined fashion. It also happens to help you prepare for life's ups and downs. That sort of security is definitely worth a few minutes' time and effort.
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