By: Jose Reyes
Savings is one of those topics you either embrace enthusiastically or avoid intensely. This is partly because we are used to focusing on today, and hoping that tomorrow will take care of itself. Wishful thinking. Let’s prepare for tomorrow, by working on it today.
As a guide, we should take our gross income, and divide it into three categories:
Gross Income 100%
Savings is a broad category, and is made up of the following: saving for specific needs, insurance and debt payments. The goal of savings is to add some stability to your financial future. Let’s look at how these parts fit together.
To understand saving for specific needs, let’s imaging you have several buckets. One is labeled “Emergency Fund”, another “Retirement”, another “House”, and still others. You then take some money from your paycheck and put into each bucket. If you are new to savings, start by putting money into an emergency fund until you reach $1,000. This will help reduce the need to borrow when you have emergency expenses. Sometimes there are needs that saving alone won’t meet in the short term. Let’s look at how insurance fits in the picture.
Insurance is substitute for savings. Insurance provides money when unexpected emergencies happen (death, illness, accident, etc). Buy insurance when the cost of the emergency is bigger than your current savings, and the total cost of insurance is cheaper than the cost of the emergency. Some types of insurance are mandatory by lenders or governments (ex. auto, home), while others are voluntary (ex. life, medical, disability). Now let’s look at the third piece to the savings puzzle.
Debt is another substitute for savings. When you borrow funds (car loans, credit cards, student loans, mortgages), you commit to repay the lender over time, with interest. Debt that leads to more income (e.g. student loans, business loans) or an asset that grows (e.g. a house) can be good, but too much debt is never good. To repay the debt, you have to reduce savings for specific needs. If you don’t have enough savings, then you have to reduce giving or expenses. This is a warning sign you’re taking on more debt than you can handle.
It may seem strange to have debt payments under Savings, but there is a method to this “madness.” Since debt payments affect how much we can save and pay for insurance, it gives a better picture of how we’re handling our money.
Savings will help set the tone for your spending. Give savings the attention it deserves, and keep a mix that strengthens your financial picture. Then Giving and Spending will be easier to manage.
Jose Reyes is a financial counselor and teaches various courses including debt management and financial planning. He can be reached at financial_counseling@ yahoo.com.