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5 Different Types of Savings You Should Have Right Now

The almighty dollar stresses us more than work, family, and even our health, according to the American Psychological Association. Anxiety over personal finances impacts health and longevity and contributes to poor decision-making.

Why do so many of us succumb to money-related stress? Because we mismanage our money. We spend too much and save too little — or nothing at all.

Every working-age adult should maintain several types of savings for unexpected expenses, and commit to funding each of those accounts with every paycheck.

Emergency Savings

Everyone needs an emergency fund because everyone faces emergencies sooner or later.

An emergency savings fund protects you from financial shocks such as major injuries, long-term illness, job loss, and unforeseen home or car repairs. However, for many people, that type of safety net is a foreign comfort.

Less than half of the respondents in a Federal Reserve survey could cover a $400 emergency without borrowing money or selling something: a sure sign too many of us live hand-to-mouth with no savings.

How Much Do You Need?

In his famed Baby Steps, Dave Ramsey recommends saving $1,000 for emergency savings as your highest financial priority. After that, he recommends paying off all unsecured debts and then padding your emergency savings to three to six months’ worth of expenses.

Households with extremely stable incomes and expenses can probably get away with one or two months’ worth of expenses. Those with irregular incomes and expenses, or less secure jobs, may need as much as a year’s worth of living expenses. It simply depends on your own financial stability and security.

When calculating your living expenses, include everything from food to transportation, housing to entertainment. Don’t forget periodic expenses as well, such as property taxes and biannual auto insurance payments.

How to Hold Your Emergency Fund

Your emergency fund should include cash sitting in a high-yield savings account or money market account. Your emergency fund savings should be highly liquid, meaning you can cash out of it immediately if you need access to it. But you don’t necessarily have to keep it all in cash.

I think of my emergency savings as a series of tiered defenses. The first tier comprises cash in my Bask Bank savings account. But I don’t like to leave tens of thousands of dollars collecting dust in a savings account, so I only keep one or two months’ worth of expenses in cash savings.

My next tier of emergency savings sits in a fund that owns Treasury inflation-protected securities (TIPS). These government-backed bonds protect against inflation, while still staying both extremely safe and liquid.

Avoid holding volatile investments like stocks and mutual funds that can lose value in bad economic times as part of your emergency fund.

Finally, I keep several unused credit cards. In a dire emergency, I can tap them, but I don’t use them otherwise.

Never, ever touch your emergency savings for anything short of an emergency.

Don’t use it to buy that new jacket you want, or holiday gifts, or pampered spa days, or that vacation you want to take. I don’t even recommend using it for car or home repairs (more on them shortly).

Emergency savings exists only to protect you from truly unpredictable financial shocks.

Retirement Savings

Can you imagine anything more depressing than going broke in your old age and living on the scraps of Social Security?

2021 study by PwC found that only 36% of Americans are on track for retirement savings, and fully 1 in 4 Americans has nothing at all saved. The average American’s retirement savings is only enough to generate around $1,000 per month in income, and that’s based on generous assumptions.

Social Security is designed to be supplemental, not a primary or sole source of income. The average Social Security payment in 2021 is only $1,544 per month — roughly equivalent to the median mortgage payment in the U.S.

Which means you need to invest and plan for your own retirement.

How Much Do You Need?

There’s no one-size-fits-all answer for the right amount of retirement savings.

Many financial professionals suggest siphoning between 10% and 15% of your income throughout your working career, but that assumes you start investing for retirement in your 20s and plan to retire in your 60s.

First, come up with a target annual income in retirement. That income does not need to have any relation to your current working income.

Your living expenses may prove drastically lower in retirement with no commute, work clothes, or work lunches. You won’t have children to house and feed, so you can downsize your home.

For that matter, you can move somewhere with a lower cost of living — perhaps a state with low taxes and housing costs, or another country where you can live on $2,000 a month.

Entire books have been written about how much you need to save for retirement. But the lightning summary is that you need to save around 25 times your desired annual income in retirement if you plan on retiring in your 60s.

If you want to retire young, save around 29 times your desired annual income because you’ll need a lower withdrawal rate in retirement to stretch your savings over more years.

Just for fun, read up on extreme early retirement and what it takes to retire in the next five or 10 years. You might be surprised at how differently you start looking at money when you question your assumptions.

The Power of Compounding and Starting Young

When you’re 25, retirement seems so far away as to be purely conceptual.

Don’t fall into the trap of procrastinating and leaving retirement as a problem for another day. The longer your money has to compound, the less you need to save.

Imagine you want to save $1 million, and you earn a long-term average return of 8%. Here’s how much you would need to save depending on many years before retirement you start investing:

  • 10 Years: $5,467 per month
  • 20 Years: $1,698 per month
  • 30 Years: $671 per month
  • 40 Years: $287 per month

Start investing a little today so you don’t have to invest every penny tomorrow.

How to Hold and Invest Your Retirement Funds

Each dollar you save will be worth less by the time you retire as inflation whittles away its value. You must beat inflation and prioritize growth. That means investing your money rather than letting it collect dust in a savings account.

Take advantage of employer-sponsored retirement programs, such as 401(k)s, and always take full advantage of employer matching contributions. If you can’t access a retirement plan at work, contribute to your own Roth or traditional IRA.

Note that Roth IRAs are more flexible, and protect you from taxes going up in retirement. Rather than take a one-time tax deduction on the contribution, Roth accounts allow your money to compound tax-free, and you pay no taxes on withdrawals in retirement.

If you’re self-employed, even for just a side gig, consider opening a SEP IRA to invest tax-free.

Don’t know anything about stocks? No sweat. Invest through a robo-advisor and let them manage your IRA or taxable brokerage investments for you.

Beyond the stock market, consider investing in real estate to diversify. That doesn’t have to mean buying rental properties — you have many options to invest indirectly in real estate without the headaches landlords suffer.

Reinvest all dividends, and never touch your retirement funds until you say “I quit” and waltz out of the office for the last time.

Pro tip: Have you considered hiring a financial advisor but don’t want to pay the high fees? Enter Vanguard Personal Advisor Services. When you sign up, you’ll work closely with an advisor to create a custom investment plan that can help you meet your financial goals.  Learn more about Vanguard Personal Advisor Services.

Personal Savings and Short-Term Goals

Since retirement and emergency accounts are off-limits, where do you get money to buy a new car, update your wardrobe, or go on vacation? From your personal savings.

Set aside money every month for these expensive personal costs, so you don’t get blindsided when your car gives up the ghost or your laptop starts sizzling and displaying the blue screen of death.

There’s nothing wrong with taking a two-week trip to Europe or buying yourself a new high-end work laptop. But you need to earmark money for it as part of your monthly budget.

How Much Do You Need?

I don’t own a car, but I travel internationally several times each year. Likewise, I have a friend who rarely travels but routinely saves up to buy $7,000 computers.

Your budget must reflect your own personal priorities. Plan out your short-term savings goals, from travel to a new car to a down payment on a house to high-end electronics. Then revisit your budget categories to reflect your priorities.

You can have anything, but you can’t have everything. For instance, a friend of mine who loves traveling had to suspend her international vacations for a year or two in order to pull together a down payment for her first home.

Irregular Expenses

Some expenses are inevitable, but they don’t hit you every single month.

For example, if your homeowners insurance or car insurance bills you annually or semiannually, rather than monthly, you should budget for it every month.

It sounds obvious, yet a shocking number of people get “surprised” by these sorts of bills every time they come due. Then they scramble around looking for money to cover it, only to repeat the process six months later.

Or consider holiday gifts. Roughly one-third (31%) of Americans took on debt in 2020 to cover their holiday spending, according to a survey by Magnify Money. The holidays aren’t exactly a surprise expense. They come at the exact same time every year. So set aside money for them in your monthly budget, by setting aside money in your irregular expenses fund.

Nor is it just holiday gifts. Birthday gifts, wedding gifts, anniversary gifts, baby shower gifts; the list goes on. Yet people keep telling themselves “Well, this month my budget got thrown off by Suzie’s birthday present. But next month I’ll get back on track!”

No, you won’t. Next month it will be a wedding gift. The month after that it will be a surprise party you throw for your brother. And so on, ad infinitum.

Finally, I would urge you to include home and auto repairs in your irregular expenses fund. Like gifts, the details vary, but these expenses are inevitable. Last year it was the furnace. This year it’s the roof. Next year it’s the rotting wood in the deck.

Budget for these irregular but inevitable expenses, because they aren’t going away. You can either live in a constant state of frenzy about them, or you can simply plan for them as a line item in your monthly budget.

How Much Do You Need?

Like every other savings category above, it depends.

If you own your own home, aim to budget around 10% of the mortgage payment for repair expenses. The same goes for a car if you own one of those. If you don’t own either, you don’t need to budget for them.

As for gifts, it depends on how much you typically spend. Start with these tips to create a holiday budget (and actually stick to it). Don’t forget other gift types too, such as birthday and wedding gifts.

And, of course, budget appropriately for all quarterly, semiannual, and annual billed expenses.

Health Savings Accounts

Not everyone uses a health savings account (HSA) in combination with a high-deductible health plan. But those who do need to contribute money to their HSA if they want to enjoy the benefits.

These accounts let you not only save money tax-free for health-related expenses but invest it for tax-free returns. They come in two varieties: a banking option that works like a regular savings account, and an investment account.

In fact, HSAs come with the best tax benefits of any tax-sheltered account. Contributions are tax-free, the money grows and compounds tax-free, and withdrawals are tax-free.

Which all means a ready source of funds in the event of a medical emergency.

How Much Do You Need?

To maximize those tax benefits, many people actually use their HSAs as secondary retirement accounts. They make the maximum possible contribution each year ($3,600 in 2021 for individuals, $7,200 for families).

That dual purpose aside, how much you contribute to your HSA depends on your deductible and on your health risks.

The higher your deductible, the more you should theoretically set aside in your HSA each year. Likewise, the more likely you are to suffer medical expenses, the more you should set aside.

And if you don’t spend your savings in your HSA on health care this year, all the better. It can continue compounding until you retire, and you can tap it then. You certainly won’t have any shortage of health-related expenses in retirement.

Final Word

Between your emergency, retirement, personal, HSA, and irregular savings accounts, it may feel like you’re saving more money than you’re spending.

If that’s true, then congratulations. You will build wealth far faster than the average American.

But retirement savings aside, the other savings outlined above exist specifically to spend.

Your personal savings empties out as soon as you hit your short-term financial goal and buy that house or take that vacation. Your irregular expenses fund gets tapped every time you shell out money for gifts or home repairs. And while you hope you never have to spend your emergency fund, it helps you sleep at night, and you don’t need to keep putting money toward it once you reach your target.

If you routinely break your budget, automate your savings to put it on autopilot. You can either have your employer divvy up your paycheck between multiple bank accounts before you touch the money, or you can set up automatic deposits from your checking account into your savings accounts.

Do whatever it takes to ensure your financial stability. That usually means protecting your money from yourself, and that voice in your head telling you how much you deserve to splurge for today at the expense of tomorrow.

G. Brian Davis is a real estate investor, personal finance writer, and travel addict mildly obsessed with FIRE. He spends nine months of the year in Abu Dhabi, and splits the rest of the year between his hometown of Baltimore and traveling the world.

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