Proverbs 21:20 says, “Precious treasure and oil are in the house of the wise, but the fool consumes them.” One of the most common financial mistakes people make is spending all of their current income on today’s needs and wants, while failing to build in savings for near- and long-term obligations. As a result, they find themselves on the financial edge, often using unproductive debt to pay for things that should have been funded through savings.
There is a better way. Many financial planners speak of “paying yourself first.” That’s not quite right, since as Catholics we should develop the habit of paying the Lord first through our charitable giving. We should give from our “first fruits” (Prv 3:9). However, once we do that, it does make sense to pay yourself second, using your remaining income for regular living expenses. Building savings for both near- and long-term obligations into your financial plan will revolutionize your financial life.
|Buying a replacement car is one expense you may want to set up a reserve fund for. Shutterstock
How can you best manage saving for multiple goals? I recommend using what I call “reserve funds.” What are reserve funds and how do they work? They are savings or investment accounts used to fund future expenses over a period of time. What types of future expenses should you use a reserve fund for? Here are several — you may think of others:
• Emergency/rainy day funds
• A replacement automobile
• Down payment on a house
• A home improvement fund
• Children’s college funding
• Children’s weddings
• Retirement funds
Today, many people borrow to pay for such things as replacement vehicles and home improvements, but it wasn’t always that way, and it’s not smart money management.
How do reserve funds work? Here is an example. Let’s say you expect to replace your car in three years. You anticipate spending up to $15,000 on a low-mileage used vehicle. You get paid every two weeks. That’s all the information you need in order to know how much you’ll have to save if you want to pay cash for your next car. The calculation goes like this:
• Anticipated timing of purchase: 3 years
• Estimated purchase price: $15,000
• Annual savings required: $5,000
• Paycheck frequency: biweekly (every two weeks)
• Amount to be direct deposited into auto reserve fund every pay period: $192.30
By following this simple approach, you’ll have set aside the $15,000 you need to replace your next car. And you’ll be debt free!
I recommend keeping your emergency and rainy day funds in one money market account. You can keep your auto and housing funds in the same money market account or in CD’s with maturities that match more closely with the time frame of your purchase. Through the use of a simple spreadsheet, you can track the balances and activity of each of the funds that make up the one money market account.
When it comes to funding college expenses for the kids and your retirement, you’ll use separate investment accounts since you’ll most likely be taking advantage of tax-favored investments.
As you saw with the automobile example, it’s fairly straightforward to know how much you need to set aside for your emergency, rainy day, automobile and housing needs. College and retirement planning get more complicated, but the power of the Internet makes figuring it out a whole lot easier. Use the calculators at veritasfinancialministries.com to help you determine how much you need to save today in order to meet your goals tomorrow. God love you!
Phil Lenahan is president of Veritas Financial Ministries (www.VeritasFinancialMinistries.com) and author of “7 Steps to Becoming Financially Free” (OSV, $19.95). Submit questions for columns to firstname.lastname@example.org.