Saving for the short term is more difficult and requires more discipline than saving for the long term, because there are no automatic means such as payroll deductions or third party drafts for setting aside short-term money. For this reason, many people never save for the short term and have one-dimensional savings. They save for retirement and borrow for short-term needs. If you want to stay out of debt, you need some strategies to save short-term money.
What is short-term savings?
Short-term savings is money you can get your hands on quickly. Think of it as a contingency savings account: money for emergency repair and replacement of big ticket items (asset replacement), money to tide you over if you should get laid off, choose to change jobs or meet with some financial setback, money for medical emergencies.
Most experts recommend that you have at least the equivalent of three to six month’s take-home pay in your contingency savings account. This is a minimum amount to have available for immediate access. Keep it in an interest bearing checking account, passbook savings account, money market account or short-term (three to six month) certificates of deposit or treasury bills.
You may prefer to accumulate more than three to six month’s expense money in your short-term savings, particularly if you have short-term goals that will require large sums of cash, such as making a down payment on a house, buying a car, replacing some other big ticket item or starting a business.
Short-term contingency savings is your freedom money. It keeps you out of debt. Long-term savings is your financial security. You need both to live debt-free. Accumulate them simultaneously, even if you can commit only a few dollars a month to each one.
Keep your long-term and short-term money segregated from each other. Don’t raid long-term savings for short-term needs. You’ll undermine your financial security.
Strategy #1: Pay yourself first
The most important strategy for building your short-term savings is to control your spending through the use of a budget. People who find it difficult to establish the savings habit don’t budget for savings. In fact, they probably don’t budget at all. Instead they spend first, then save what’s left. The problem is: There is never anything left to save.
Your budget should treat savings as a fixed expense. To succeed at saving, it must be the first expense you pay each month. You won’t miss a few dollars if you set them aside before you start spending. This is popularly characterized as the “pay yourself first” strategy.
Put this money in a share draft account at a credit union, accumulate it in an interest bearing checking account or in a money market account at a bank or in a passbook savings account. Make sure the credit union is a member of NCUA (National Credit Union Administration) and the bank is a member of the FDIC (Federal Insurance Deposit Corporation). Accounts in member institutions are insured up to $100,000.
The amount you set aside is not as important as the act of saving itself. The habit of saving is the key to accumulating substantial sums of money. By setting aside a portion of your earnings each month before you start spending, you will acquire this habit. If you also have something left over at the end of the month, then save that, too.
Strategy #2: Save money freed up by debt repayment
After you pay off an installment debt, take the money you had budgeted for the monthly payment and add it to savings. Keep making that installment payment. Only pay it to yourself instead of the lender. This strategy works because you’re already used to doing without the money.
You may want to put this money into a separate asset replacement account for the day when you will need to replace your car, refrigerator, washer, hot water heater, etc. The loan you took out probably purchased some asset in the first place. Just keep making the payment to the asset replacement account after the debt is paid. You won’t have to borrow the next time you need to buy an asset—or ever again.
Strategy #3: Save salary increases
When you receive an increase in salary, save it. You won’t miss the money; you have been living without it up to now. Just keep doing without it and put it into savings.
Don’t raise your standard of living every time there is an increase in cash flow. Save the increase and keep your standard of living the same—for the time being. Increase your standard of living on the basis of your savings, not cash flow. Until you have a sufficient amount of money in short term savings to insulate you from the necessity of borrowing for emergencies, you cannot afford to increase your standard of living.
Strategy #4: Save windfalls
Save all windfalls of cash such as bonuses, gifts, overtime pay, income tax withholding refunds, proceeds from garage sales, etc. This income is not figured into your budget, so you won’t miss it. Windfalls happen more often than you realize. It’s just that in the past you have spent them and then forgotten about them. These jolts of cash will quickly boost your short-term savings and continue to add to your savings over time through the interest that is earned.
If saving all windfalls is too harsh, then reward yourself by spending a fourth to a half of the windfall and saving the rest, especially if the windfall is hard earned as in the case of a bonus or overtime. But before you do this, consider how much closer you will be to your savings goals if you save the entire windfall. I always allow myself the option of spending a part of any windfall. But I usually save it all. I much prefer the satisfaction gained by the additional progress toward my goal rather than the immediate gratification I experience when I blow a portion of a windfall.
A good rule of thumb for any income : If it is not figured into the budget, then save it.
Strategy #5: Save the “extra paycheck”
Another way to save for the short term is to trick yourself into saving. If you get paid weekly or bi-weekly, you get an extra paycheck a month every so often. Budget based on the income you receive in a regular month: four paychecks if you are paid weekly or two paychecks if you are paid biweekly. When the extra paycheck shows up, save it. You haven’t budgeted for it, so you won’t miss it. If you’re paid weekly, you will have an extra paycheck every three months. A bi-weekly schedule will generate an extra paycheck every six months. By saving those extra paychecks, you will set aside 7.7 percent of your net earnings.
Copyright 1997 K.C. Knouse
K. C. Knouse is the author of True Prosperity: Your Guide to a Cash-Based Lifestyle, Double-Dome Publications, 224 pages