Savings

How will I handle an emergency? What will I live on when I retire? How will I send my kids to college or pay for their braces and weddings? Most of us have asked ourselves these and other questions relating to events in our lives that require a substantial amount of money. When one of these events occurs, where will the money come from? The answer is you. All it takes is a little bit of planning and a lot of patience. I know, I know, it sounds boring, but having money available when it is needed will pay off in the long run.

Personal and family savings can be broken down into the following categories:

• Emergencies
• Retirement
• Planned purchases/expenses
• Investments

Each of these categories can and should be handled differently. I'm going to explain why you need to break your savings into separate categories.

Emergencies
It's recommended by most personal finance authors to have at least 3 months of expenses set aside for a rainy day. Why? Let's say you get laid off from your current job. How long would it take for you to find another job with the same pay and benefits? If it took you 2 months and you have an emergency fund in place, you can continue to pay the mortgage or rent, buy groceries, and keep the lights on while you look for your next job.
Your emergency fund should be set aside in a savings or money market account that gives you quick access, but is somewhat inconvenient (so you don't spend your emergency fund on non-emergency items). Some authors suggest setting aside 6 months worth of expenses (if you are a single-income family, if you have one or more dependent kids). Once you reach your goal of 3 or 6 months (or somewhere in between), you should stop putting money into this fund and move on to another fund that earns more interest (see retirement and investments below).

Retirement
The U.S. government offers many tax-advantaged retirement options (and I'm not talking about social security), such as a 401(k) through your employer, an Individual Retirement Account (IRA) and variations on those two accounts (Roth 401(k) and Roth IRA). The advantage to a 401(k) and an IRA is that you can put money in those accounts before paying income taxes on that money. When you become old enough to retire, you will pay taxes on that money when you begin to withdraw from those accounts. The Roth 401(k) and Roth IRA require that you put money that has already had income taxes paid, and when you retire you can withdraw the principal and interest tax-free.
A retirement account is a long-term investment (5 or more years of adding principal and earnings from your investments in the account). Why should I set up and contribute to a retirement account? As stated above, its tax advantages are either no taxes when you deposit into the account (401(k) or IRA), or no taxes when you withdraw (Roth 401(k) or Roth IRA). This translates into a lot more money for you to keep when it comes time to retire.

Planned purchases/expenses
Got your eye on a new car? How about a new computer? Instead of signing up for payments (which require you to pay back the original amount plus interest), find out how much the item costs and decide how much you will set aside (save) from your paycheck each month until you can pay for the item. An advantage to delaying purchases is that during the saving period, you may find a better deal or decide that this thing won't make you happy and you no longer want it.
Infrequent expenses, like the dreaded car insurance payment, can be managed by determining how often you pay the bill. If you pay it once a year, take the total amount, divide by 12 (months), and save that amount each month in a savings account. When it comes time to pay the bill, you have the total amount available and can pay the amount in full without giving it a second thought.
Why save for planned purchases and expenses? Peace of mind comes when you already have the money available to pay for an item or to cover an expense. Yes, sometimes it hurts to spend your hard-earned cash, especially when you begin saving and it starts to add up.

Investments
Investments are vehicles that allow you to build wealth (earn money) outside of your day-to-day job. Interest works 24 hours a day, doesn't take vacations, and when compounded, adds up to a lot more than the original principal. You can either be on the receiving end of interest payments (investments) or on the paying end of interest (carrying a credit card balance, car loans, etc).
Contributing to long-term investments ensures that you have a sustainable income in the future that isn't dependent upon your current day-to-day job. It ensures that you will have money available to send your kids to college, buy a newer car every couple of years, buy a summer cabin, or whatever you dream of doing.

What are your savings goals? Do you contribute to each of the categories above? Please contribute by leaving a comment below.