Savings 102
Reach your savings target with the PFP Financial Tracker and Budgeting Template! Need guidance? See the savings principles applied to buying a car.
In this edition of The Personal Finance Project Newsletter:
🔄 Clarifying previously mentioned savings principles.
🔎 Where is the Target? Saving for Inevitable but Undefined Expenses.
🚙 Applying savings principles... an example.
Prerequisites
August 15th, 2022 - Savings 101
Savings 101 Recap and Clarification
Principle #1 - Emergency Savings account 🚨.
Your emergency savings account should cover your living expenses for a period of time long enough for you to resolve the emergency and generate a sufficient source of income. Living expenses are different for everybody and depend on many factors, so the question to ask yourself is “what do I absolutely need in order to live?”. As a young adult with low/moderate living expenses, a few months supply should suffice ✅.
Principle #2 - Defined Savings Targets 🎯
We discussed using Savings Funds to identify our progress across multiple Defined Savings Targets. I want to clarify that this principle is Defined Savings Targets (not Savings Funds). Think of the Savings Funds as a tool or method applied to achieving Defined Savings Target.
Defining a savings target is reliant on answering two questions 🧐:
1. How much money will I need?
2. When will I need this money?
With answers to these questions, you can decide how much money to contribute to each savings fund in each period.
But what about non-emergency expenses that come unexpectedly? Let's look at a third savings principle, Saving for Inevitable but Undefined Expenses.
Where is the Target?
Principle #3 - Saving for Inevitable but Undefined Expenses 🤷♂️
"Inevitable" - We will all face events that are bound to happen. Sometimes we can anticipate these events and other times we cant.
"Undefined" - Whether the event is anticipated or not, the nature of these expenses limits us from defining the exact time it will take place or the costs associated.
It is natural to overlook things that cant be quantified, but preparation for inevitable expenses is financially responsible even when these expenses are undefined.
Some examples of Inevitable but Undefined Expenses include:
🔧 car repairs
🚑 uninsured medical appointments
🏠 new appliances or home repairs
🐶 pet care
... the list goes on.
But wait, can't these examples be classified as emergencies (and thus be funded using your Emergency Savings account)? Ultimately, they could be, but consider this:
Saving for Emergencies means saving for the costs of living for the duration of the emergency. Though the length of the emergency is undefined, you can decide to save for a set time window that you think will be sufficient enough for you to generate new income.
Inevitable but Undefined Expenses differ because many of us don’t consider these expenses in our cost of living, and funding these expenses with our Emergency Savings leaves us vulnerable if an emergency were to happen.
Inevitable but undefined... okay, how in the world do I prepare for this? Let's apply this principle (and others) to the example of buying a car ⬇️.
Applied Principles - Buying a Car
This is Jessy 👱♂️.
Jessy wants to buy a used car for $10 000. He has an idea of the type of car he wants, and how often he will use it, though he doesn't know which exact car to buy. It is September 2022, and Jessy wants to buy the car in 1 year from now.
Principle #2 - Defined Savings Target
Jessy has a defined savings target of $10 000, and is going to contribute to a “New Car" savings fund every month until he reaches his target. After some quick math, Jessy's monthly contribution to the new car fund must be $833.34 ($10 000/12 month = $833.34/month) 📈.
Monthly Car Expenses 🗓
It's now July 2023, and Jessy has almost reached his $10 000 target. He gathers quotes on insurance rates.
Given the guidance of insurance professionals, Jessy estimates that the cost of insurance will be $200/month (of course, Jessy is a young male and is required to pay a lot more in insurance). He estimates that he will spend roughly $300/month in gas. In total, Jessy will need to pay roughly $500/month to use his car.
The question is: does this $500/month count as a cost of living (i.e. must it be considered in the Emergency Savings Account?). Well… it depends!
Principle #1 - Emergency Savings Account (considerations…)
If Jessy feels that using his car in the case of an emergency is absolutely necessary, then his Emergency Savings Account should cover this monthly cost.
If this is unrealistic for Jessy (like many of us) he could choose to ignore this $500 monthly commitment with the understanding that in the case of an emergency, he has NOT saved enough to use his car.
In this case Jessy might be biking… 🚴
Other Car Expenses ❓
The costs mentioned above are definable, meaning you can anticipate when these expenses need to be paid and roughly how much they will be. But what about the Inevitable but Undefined Expenses associated with owning a car?
Truthfully, there is no magic formula or rationale to prepare for this, but let’s look at the factors impacting Jessy’s savings decisions.
The first factor is the necessity of driving to Jessy’s lifestyle. As discussed earlier, if driving is an absolute must then he should consider saving for all defined AND undefined car expenses in his Emergency Savings Account.
The second factor is Jessy’s current income and what he can realistically afford to save now and in the future. Lots of extra cash flow means Jessy can afford to save more, but little extra cash might limit how prepared Jessy can be.
When saving for Inevitable but Undefined Expenses, start by designating a Savings Fund to the cause, say, the Car Repair Savings Fund. Jessy can choose to pay into this Savings Fund using lump-sum payments, fixed periodic payments, sporadic payments in times of extra cash flow, or a combination of the three.
A responsible savings plan for Jessy is to contribute an initial lump-sum payment to the Car Repair Savings Fund to cover (or partially cover) a potential undefined expense in the short term. Afterwards, Jessy should make fixed periodic (monthly) payments to grow this Savings Fund, increasing his preparedness for undefined expenses over time.
Principle #3 - Saving for Inevitable but Undefined Expenses
If Jessy’s initial lump-sum contribution is $1 000, with additional monthly contributions of $50, he would have $1 600 in the Car Repair Fund after 1 year! (($50/month x 12 months) + $1 000 = $1 600).
Though this may not cover the cost of everything, it surely prepares him for the most probable inevitable expenses like minor repairs 🔧, oil changes ⛽️, new tires 🛞, tow truck service 🛻, etc..
Using the Budget Table to track savings progression.
Notice the monthly contribution of $833.34 to the New Car Fund each month from September 2022 to August 2023.
Additionally, notice the lump-sum payment to the Car Repair Fund of $1 000 to the Car Repair Fund in September 2023, and subsequent monthly contributions of $50 starting September 2023.
Lastly, notice the monthly car expenses (totalling $500) each month beginning September 2023.
**the table was slightly cropped and modified to embed into newsletter**
Download the PFP Template to access the Budget Table pictured above.
❗️ REGARDLESS OF METHOD, THE POINT IS THAT BEING PREPARED FOR INEVITABLE BUT UNDEFINED EXPENSES IS FINANCIALLY RESPONSIBLE❗️
To Be Continued...
You're reading the second newsletter in the Savings series. How many more will there be? Who knows! I have some more savings content that I'll be covering over the coming newsletters, so stay tuned for the next newsletter in mid-September!
⏰ What's to come in future newsletters:
Saving for the Sake of Saving - The Pay Yourself First Principle
Saving versus Investing - whats the difference?
Budgeting and how to establish a savings plan.
✅ What we've covered today:
Some clarification of the principles covered in Savings 101
Introduction of Saving for Inevitable but Undefined Expenses
Buying a Car - Applying Savings Principles to Reality