Have you ever really wanted something that was just too far out of your financial abilities to buy? Maybe you were walking along the waterfront and it was that 32’ cruiser with a fishing set-up. Or maybe you’ve always wanted to take that trip to Machu Pichu. Or maybe you wanted to take your gaming to the next level with that awesome new Asus gaming rig. Or maybe it’s something much more utilitarian like building a garage or storage shed. Regardless of what it is, there are likely things that you have really wanted but you either couldn’t afford or you felt would be too big of a strain on your finances – this is where having a special purpose, targeted savings account will help you.
In this article I’ll review what I mean by a targeted savings fund, how you should go about building one, and some common pitfalls that can derail you on your savings goal.
What is targeted savings
Quite simply, it is a pool of money that you have saved specifically for one reason and one reason only. This money should be stored in an account by itself that you try to avoid using for any other purpose. This is often money to either buy a luxury item, take a once-in-a-lifetime trip, or potential to use for something like a down-payment on a home.
It is important to remember that this account is something that is truly optional, and as such is something that you should only fund after you have built your emergency savings fund, and after you have maxed out your employer match on the 401(k). If you aren’t doing those then you are really doing yourself a disservice.
Depending on the size of the purchase, the anticipated amount of time it will take to save the money, and your risk tolerance you have many options. Typically, if saving a smaller amount or only trying to save for a few months to a year or two then you’d be best served by putting the money in an interest-bearing checking or savings account. However, if you are trying to save substantially more, and if you think that it will take you multiple years to get there, then you might want to consider investing into the stock market via low-cost ETFs (but knowing that the market does have down years and you may lose money).
Building a targeted savings account
There is no right or wrong way to do this, but in general there are three ways you can go about trying to build this account:
- Slow and Steady. Most people go about building this account by taking a slow and steady approach that they can sustain over the long term. This often involves putting something like $10-50/week into your targeted savings account and watching it grow through time. With small amounts like this, you likely won’t even notice, but at the end of a year you will be pleasantly surprised. The amount deposited depends on your ability to put money in and the amount you need to save. For something like a down payment or to buy a car you may need to put in much more.
- Save by Substituting. One way to really gauge how much you want something, and to create good financial habits in general, is to save money by substituting something low cost for something you normally buy that is high cost. For example, if you normally eat lunch out everyday consider swapping out that burger and fries for a sandwich from home, and then take the amount you normally spend on that lunch and deposit it into your account. This method can be scaled to anything from swapping in water for a soda (in which case you deposit a $1 or $2) to more substantial trade-offs like skipping out vacations for staycations (or maybe taking a simple camping/hiking trip instead of the 4-star beach hotel). I once had a friend who told me that quitting smoking save him $3000/year.
- Windfall. For people who either get periodic bonuses, commissions, or tips using the windfall method can be really powerful. For example, a salesman who has a blow-out quarter can squirrel away that extra commission maybe twice a year, allowing them to put several hundred to several thousand into their targeted savings at one time, but with nothing in between those windfalls. For people with the option to work overtime, maybe you put away some of that optional overtime pay into your savings account.
Of course, you can combine these three methods, or you can just make ad hoc deposits… $10 here, $5 there, until you hit your goal. There are no rules – but your dedication to saving for that particular reason will tell you something about how badly you want it.
Pitfalls along the way
The biggest pitfall that I see is caused by FOMO (fear of missing out). People experience FOMO when they are presented with a choice to do, or not to do something, such as go to a concert, night out at the bar, out to lunch with co-workers, etc. They believe that if they don’t do it, then they might miss out on something amazing, might miss out on hearing the latest gossip, or might just be forgotten by their friends. Although, they know very well that in most cases this completely just an illusion and that they wouldn’t miss out on anything at all.
However, FOMO makes people spend money, and often a lot of it, at the detriment to their ability to save for long-term goals. Although there is nothing wrong with going out and spending money on social occasions, you should do it because you really want to do it, and not because of FOMO.
Another common pitfall is using your targeted savings account as a piggy-bank for whatever catches your fancy. For example, you are saving for a boat but you dip into that savings to buy an iPad. This not only derails your savings plan for the item you are saving for, but it can also distort your view of your overall finances. If you find yourself doing this often, you need to ask yourself if you REALLY want the item you are supposedly saving for or not. If the answer is yes, then take measures like sticking a picture of it in your wallet or beside your home computer, so you see it every time you fire up Amazon. If the answer is no, then no big deal – just put that money in your regular accounts.
Saving for a specific goal – targeted savings – is a great way to help you build money so that you can make one-time large purposes. The amount you need for that item should dictate how quickly you try and save and how much you put in on a regular basis. There is no right or wrong way to do it, but we suggest one of the three ways outlined above.
Finally, as a special note on this subject. If you are saving for an item like a boat, car, truck, etc you need to think not just about how the purchase price affects your finances, but also how the ongoing costs like insurance, dockage, taxes, etc. will be affected as well.
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