We earn money and we spend it. But our ability to earn money and our need to spend it aren’t always particularly well aligned. By setting aside some of the money we earn, we’re creating a financial buffer. We’re sacrificing our immediate desires in favour of our future needs. And it’s important that we do so.
We earn money in a broadly linear way. We have a standard weekly wage or annual salary that, in most cases, stays pretty much the same until we get our next promotion or pay rise. But our expenditure isn’t always so linear. Or so predictable.
Kids need new clothes. Dogs injure themselves. Stuff breaks and needs to be replaced. Cars and houses need to be bought. And we’ll no doubt wish to continue to eat, drink and live in a house once we’ve reached the end of our working lives.
This means that we can’t just spend our money as we earn it. Because while we may sometimes earn more than we spend, at other times we’ll spend more than we earn. And at some point, we’re not going to be earning any money at all. Consequently, we need savings.
I appreciate, of course, that this is easier said than done. But it terrifies me when I read things like one in three people would struggle to pay an unexpected £500 bill without borrowing money. Savings are important, whether you’re setting aside a fiver a week or five million.
With my own (modest, but not exactly high-flying) personal finances, I think about five different ‘pots’ of money. And I adopt a slightly different strategy for managing each one.
First, I have what I think of my ‘working capital‘. This is the money in my current account that I anticipate spending each month on regular outgoings, like groceries, council tax, pet food and such like. It’s the basic cost of being alive on a day-to-day basis. I monitor my expenditure carefully and seek to reduce it when I can, but essentially this working capital comes into my bank account and goes out again.
Second, I have my ready access savings. This is where I hold any ‘spare’ cash until I’ve decided what I’m going to do with it. It’s an instant-access savings account that’s linked to my current account. I might end up spending it on something that I pay on an annual basis, like car insurance, or I might save it. I try to keep my ready access savings at the level of a couple of months of my net salary.
Third, I have my ‘rainy day fund‘. I keep this in a separate bank account (in this case, a cash ISA) that earns interest. This is my ’emergency fund’ for when something big breaks, like the car. It’s also where I put money if I’m saving up for something, like the improvements that we’re currently making to our house. I try to keep the emergency fund element at about six months of my net salary.
Fourth, I have a small investment portfolio. This is held in a range of mutual funds (more about my approach to investing in a later post) via an investment platform that I trust, that I find easy to use, that offers competitive fees and that doesn’t try to bamboozle me. I only invest money that (a) I know I won’t need to spend in the next five years and (b) that I could live without if I lost it.
And finally, I have my pension savings. With my pension, I’m saving for the time in my life when I don’t feel like working quite as much – or at all. I have a pension account with a large financial services provider, select my own investments and benefit from a delightfully low fee. I’ve been paying into my pension fund since I was 23 and now pay a personal contribution each month from my net salary (I get the tax back) and an employer contribution from my company.
The rationale for having an investment portfolio and a pension, by the way, is that I can only access my pension when I’m 58. And so my investment portfolio could tide me over in the event that I wanted to retire or scale back my work before then. Which is unlikely, to be honest, as I love my work. But you never know.
Indeed, you never know what’ll happen in life. But even a modest financial buffer can take a lot of the worry, pain and hassle out of whatever life might bring. No matter how and how much you save, savings matter.
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Disclaimer: I’m not a financial advisor. The information on my blog doesn’t constitute financial advice or recommendation and shouldn’t be considered as such.