For years, my step-father has talked about the value of “funding” accounts for savings purposes. He would accomplish this by tracking, with a hand written ledger, all the money earmarked for a specific purpose. Growing up, I often heard him talk about the value and importance of practicing this habit.
I guess I was lucky to have some personal finance education provided in the household throughout my childhood. Of course, I did not follow this advice until decades later…. 🙂 I guess sometimes you have to go through the “school of hard knocks” first before the lessons are truly learned.
In general, most people should already have two funds: their savings for retirement, and a decent emergency fund. Why not do the same for other savings goals? How about saving for items on your bucket list? What’s that, you say? You don’t have a bucket list? Well, why not? What are you waiting for? Funding is an excellent way to determine what your savings goals cost and to monitor savings balances and track your progress.
Now that I am on board with this concept, we have discovered this is an excellent way to save for important goals. This also helps motivate us to keep saving and provides a way of tracking our goals. When we know the reasons or “the why” these savings funds are in place, this tends to give more power to savings.
Create specific goals for savings
As I mentioned earlier, my step-father brought home this concept to the family. Once I started my professional career as a controller in one of my many lifetimes, I realized that working with accruals is the same business concept as saving money for personal reasons.
A business accrual is money that is set aside on a systematic and periodic basis to have expenses covered when the cost actually occurs. For example, a business managing once a year insurance premiums would accrue 1/12 of the annual cost each month. The intention is to plan these accruals as close to the actual cost as possible, and do ongoing analysis of these accounts on a monthly basis to ensure correct estimates.
Nearly every publicly traded corporation works on an accrual basis as opposed to a “cash” basis. They will go through internal and external audits that will also analyze major accrual accounts to ensure proper financial controls are in place and the balances are reasonable for the intended expenses. This keeps companies from creating “slush funds”.
The cash basis vs. accrual basis is an IRS distinction that is important for filing business tax returns; it determines how expenses will be treated. Did these expenses actually occur or did the business accrue for them? The accrual basis allows you to expense them now as opposed to the cash basis method that requires you to actually have paid the bill. Make sense?
So why not take some of this same logic and accrue for personal periodic budget items to help smooth the expense out over the year? Doing this certainly helps my wife and me plan for bumps in the monthly budget.
Ok, let’s take a business look at some personal expenses. Here are a couple of examples:
- If you pay $3,600 a year for property taxes, budget $300 per month.
- If you have a $1,200 a year cost for property insurance, you can budget $100 per month.
This can work the same for car insurance and repairs, life insurance, and other once or twice a year expenses.
I have created and named each of these funds so they take on more meaning and break these items down into more discrete categories. Some of our names include a World Cruise Fund, a Tahiti trip, a Europe trip, a new “used” car account, and let’s not forget the kitchen remodel savings.
A side benefit that we have noticed is that it is harder for us to rob/borrow funds for items not intended for the specific savings purpose. Why would we want to take money from an emergency fund to buy a TV? Certainly we would not take money from a vacation trip fund to pay a repair bill to the furnace. Just like this picture implies, “it doesn’t seem right”. (Blades of Glory movie reference)
As a side note, it helps being intentional when you are setting these savings objectives using a SMART (Specific, Measurable, Achievable, Relevant, and Time-bound) approach. We are fulling using these elements for successful goal setting in our personal lives today.
Create a budget around funding savings
We set up a payroll direct deposit into our credit union. This credit union allows us to have multiple accounts that we can give “nick names” to. Creating a name for your goals gives more meaning and energy behind their purpose. So we created accounts that included remodeling, insurance, property taxes, car fund/repairs, emergency fund, vacation, and a general bucket list account. Unfortunately, we were limited as to how many deposit accounts our payroll department would allow the check to be split to. So we set up an automatic and recurring transfer from our main account to the various savings accounts based on the dollars we wanted allocated.
Another approach is to simply drop all your money into one savings account and keep a separate old school ledger to keep track of each funds balance.
This makes the budgeting process very easy to estimate for each of those categories. Our budget demands that we find a home for every dollar. Our monthly budget has to work with the remaining funds after these saving items are tackled first. What is left after all the expenses and savings are filled gets dumped into the debt snowball. Then, once the debt snowball has been killed, all our remaining budget funds will be dropped into named savings categories. We can’t wait for that day to come sometime next year!
The last piece of the puzzle is tracking all of these savings items. Quicken has been our tracking tool for years, so all of these transactions get updated into our system. I have some automatic transfers built in that I post each month to allocate for each of these savings goals. Should we need to change anything for a particular month only, it is an easy update in Quicken. There are also many online tools you could use such as Mint and My Spending Plan that could work for your situation.
Funding makes it simple to know what you can spend
A TV commercial or flyer comes in the mail talking about a great sale on furniture. Heck, the holiday is coming up so there has to be sales coming. We have been planning on buying a sleeper sofa for a multi-use bedroom. It’s time to reap those holiday savings – right?
How much do we have set aside for this purchase? Easy – just look at the Quicken balance for this named savings account. Do we have enough? And if so, do we want to buy it now? Ok, let’s buy it!
The best part of this funding is that when a very large bill for things like property taxes comes in the mail, I simply transfer the money to the checking account and pay it. It doesn’t affect our monthly cash flow one bit.
Smooth out life’s expense bumps
When fully embraced years back, this concept of funding savings made periodic expenses much easier to plan for. Before that, it was tough budgeting because potential expenses can swell up or down by thousands of dollars each month.
Our budget: A palace for everything and everything in its place!
We now have measurable goals that we track each month. It only takes about 20 minutes to review our prior month’s expenses and project next month’s final budget plan. We identify, track, and analyze each category, knowing we have directed a home for the dollars that are so dear to our financial independence. By looking at our savings balances and having a short discussion about them, we are measuring what we have planned for, and can adjust their course each month if needed.
It is great directing a home and name for your dollars – playing offense. Why not plan for expenses and not worry about the hit to your finances when a large and expected bill comes in the mail? The key is to smooth out the bumps in the road and make your budgeting simpler. It certainly makes it easier to plan and sleep at night. This funding approach helps us be better prepared and understand how we can make improvements to our existing budget each month.
Have you created multiple savings accounts? If so, have you learned any new tricks or traps not described in this post? Do you have a different approach?