Three Critical Kinds of Savings

Here's an article from Yahoo detailing the three critical types of savings. The three are:

To put your savings into context, think of your finances as a wedding cake. The bottom layer is your long-term savings. The goal is to compound that long-term money into a wide, deep foundation for your finances. Ideally, it will eventually be the biggest piece of your cake, broad enough to support a long and active retirement. Since it's the bottom of the cake, it is the least accessible. Leave it alone until the proper time has come; otherwise, your cake will crumble.

Short-term savings first appear in the second tier of the cake. This is the big-ticket fund you plan to spend within about five years. It might be five years' worth of living expenses if you are already retired, a college fund if you have older kids, or a house down payment. This is also where you stash money earmarked for the new roof, new car, or even a major vacation. CDs or short-term bonds can be used for these predictable expenses. Being the middle tier, it should be accessible sooner than the stuff in the bottom layer, but not until the proper time.

The top tier of the cake is your rainy-day fund, your peace-of-mind money. It's there for medical emergencies, car-repair emergencies, pink-slip emergencies. Think of it as the credit-card-avoidance fund, if you like. This money needs to be readily available -- but not too readily available, if you know what we mean. A money market account with check-writing privileges would be a good place to keep it, but your everyday checking account probably would not. You don't want to start thinking that a trip to Cancun is an emergency.

Interesting article, though we do it a bit differently at our house. We combine the last two, so we end up with simply short-term savings and long-term savings (retirement and college are the two biggest parts of this group). Guess our wedding cake is a bit too short for Yahoo. ;-)

Comments

[Michael Blackburn]

For that middle tier, look for a CD into which you can make regular deposits. I use Wachovia, and they have a one-year "Systematic Saver" CD (currently earning 2.9%, up from 2.25 when I opened it). I put a big chunk in, and agreed to make contributions on a regular basis (for me, the 4th and 18th of the month). While the interest rate isn't a world-beater, it's a great way to create a "hands-off" vehicle for, well, systematic savings. When the CD matures, I will have enough in it to roll it all into a much-larger (and better-interest-earning) savings/investment account (probably a 5y CD ladder). All told, I put away 20% of my income into these three categories. 10% goes to my 401(k), 2.5% into the CD, and another 7.5% into a high-yield savings account at Emigrant-Direct.

[Jose]

I combine the short and the emergency fund into one, and I add a kind of saving not specific on that list: retirement.

I have a recent article on that on the blog, including suggested investment instruments for each kind (actual companies and mechanics).

[DSD]

Michael: Why tie up your money for a year in an CD that earns less than your EmigrantDirect account?

[Michael Blackburn]

Precisely because it ties up the money for a year (or less, see below). That's middle-tier saving in a nutshell: accessible, but not THAT accessable. The difference in interest is wider now than it has been in the past, but it's still only 0.6%. At the level of money I'm talking about, we're talking a very small actual difference in income.

I get two psychological benefits from this system: I'm putting money AWAY away (can't touch it), and I can add to the amount, yet keep the same maturity date. In addition, I get the benefit of continuing & deepening my relationship with Wachovia. I'm sure they know I could could get a better rate for that money elsewhere, and they are very accomodating in dealing with any minor issues (such as questionable fees) that come up when dealing with my checking accounts there.