I’m on a mission this month to help you grow your savings. By savings, I mean more money in your account. More precisely, I’m referring to more money in your savings account versus your chequing account. More on that in a second.
In Part 1 of this series on saving money, we looked at the following:
Now we’re going to turn our attention to the way that we talk about saving money, and its consequences.
Have you ever said something like this: “I found the widget I was looking for on sale for 40% off at Store X. I saved a lot of money!”
Or, “I intend to save a bunch of money on my Christmas purchases by shopping during the Black Friday sales”?
You know what I’m getting at here. Whenever we buy something at a reduced price, we talk about it as though we’ve saved money. But have we really saved money or have we, instead, simply paid less for something than we’d anticipated?
I’m going to buck tradition here by playing Devil’s Advocate about the way that we talk, and think, about saving money. To illustrate my point, let’s walk through a scenario using two fictional people.
Susan’s twelve-year-old dryer was dying. She did some research online and identified a couple potential problems. In both cases, it wasn’t the worth the cost of repairing her old appliance, so she looked around and found a deal for a replacement dryer. She expected to pay $800 for the unit, but was delighted to find it on sale at a local store for $650. Susan quickly grabbed the deal and felt pleased that she had saved $150.
Coincidentally, Jennifer found herself in exactly the same boat. She bought the same dryer, for the same promotional price. Unlike Susan, however, she took the $150 in “savings” and transferred it to her high interest savings account (HISA). When she did her monthly review, she invested the funds.
Did both women save money? I would argue that Susan did not. She simply reduced her expenses by $150 for the month. The latter amount stayed in her chequing account, where it was absorbed into her monthly cash flow.
Jennifer, on the other hand, actually pulled the $150 out of her operating account and put it into a savings account. This key step formalized the savings.
“Come on,” you might argue. “If you don’t spend the money, then you’ve saved it.” My point is, how do you know if you’ve saved it? If the money keeps floating around in the account from which you pay all your bills and withdraw money for purchases, how do you know it won’t get spent? Money that is both visible (i.e. in your daily operating account) and accessible is a temptation that many find hard to resist.
In order to understand why it matters to pull extra cash, or cash not spent, out of chequing and park it in a Savings Account (albeit temporarily, until you invest it), it would be useful to agree on a definition of terms.
Economists typically define savings as “the amount of money left over after spending”. In other words, if you earn $4,000 per month and you spend $3,200 in a given month, economists suggest that you have saved $800. This is the working definition espoused by many in the personal finance space.
I have a problem with this definition, because it doesn’t necessarily mean that the $800 is being reserved for spending down the road. Who’s to say you won’t spend it next month if the money is readily available in your chequing account?
I find the following definition, from this post on Quora, much more useful:
Saving is the act of spending less than you earn in income, and placing the remainder into a reserve account for later use. It’s a verb. Savings is the actual quantity of funds in that reserve account, or another name for that reserve account.
There’s no gray zone here. Money is considered to be part of your savings when you move it into a reserve account, otherwise known as a Savings Account or other investment vehicle (e.g. tax-sheltered investment accounts, other investments, etc).
The field of Behavioral Economics provides us with compelling data showing the benefits of separating the money we access for day-to-day use and the money we reserve for the future. Consider the following, as discussed in this article:
The World Bank ran a study in Kenya to increase savings for health expenses, in which they provided residents with lockable metal boxes, a key, and a passbook to record saving goals and deposits. They found that, besides goal setting and increased security, the act of labelling the money for a specific use inhibited using the money towards any other purpose – coined the labelling effect. By exploiting mental accounting, where money belonging to different categories are perceived differently, the researchers succeeded in increasing savings. Similarly, partitioning money for different, specific purposes can motivate saving behavior.
In the above example, it’s not clear that the labelled funds were in separate accounts. For those of us who live in a world of ubiquitous online banking, partitioning money into separate accounts, which we label for specific purposes, is easy. We can take it a step further by automating the savings. (More on this later in this series.)
This one’s easy – choose whichever pays you the most in interest. Typically, that means a High Interest Savings Account (HISA).
Here’s what I’ve learned after scouring the offerings over the last couple of years: Brick-and-mortar banks typically do a dismal job of paying interest on savings accounts. Some don’t even crack 1%!
Others offer teaser rates, like National Bank’s 2.75% HISA promotional offering. The problem with these is that they don’t make sense over the long haul. When you read NB’s fine print – which, incidentally, is buried in a not-easy-to-find page labeled Legal Disclaimers – you discover that after a few months, the interest rate drops to 1%.
I’ve placed my family’s Savings Fund money in EQBank’s HISA. They have been offering 2.3% for ages now. While you wouldn’t want to leave your money growing at only 2.3% forever, it is a decent rate for a Savings Account. At the very least, your money is growing more quickly than the rate of inflation.
If you’re earning anything less than 2% – roughly the rate of annual inflation – then your money is losing purchasing power. As the cost of goods goes up, your money doesn’t keep pace; hence its diminishing buying power. Look for an account that consistently pays you north of 2%, if you can.
This one’s entirely up to you. Whatever works!
Some people find it helpful to partition their funds based on the goal for the money. For example, they might have an Emergency Fund, a Travel fund, a New Car fund, and so on. I heard from one of my Women’s Money Group members that she recently purchased a computer and booked a holiday using funds set aside in separate accounts for those purposes. It acted as a motivating factor for her.
If it helps you save money at a faster rate, then by all means create multiple savings accounts. As long as the funds are separated from your operating cash, you’re good to go.
The reason to care about growing your savings is that every dollar you save, and grow, in a separate account buys you time freedom, peace of mind, and/or access to something you value highly down the road.
Here’s my suggestion for you moving forward. First, if you don’t already have one, open up a High Interest Savings Account, or several depending on your preference. Look for accounts that pay the most interest on a consistent basis. Target more than 2% if possible.
Second, the next time you “save” money by paying a reduced price for an item, take the difference and transfer it to your savings account. It’s easy enough to do this every time you pay less for an item.
If we’re talking about just a few dollars, you can add up the savings at the end of the week. A quick scan of grocery bills and other receipts will help you get a ballpark figure. Even if you’re off by a few dollars, it doesn’t matter. The point is that you’re going to start shifting money out of your spending account, which is essentially the role a chequing account plays, and into a savings account.
In the next post on this series, I’ll take a look at circumstances when it does not make sense to do this.
In the meantime, have fun with this and let me know how much you save! I look forward to hearing your stories.