I’m on a mission this month to help you grow your savings.
By savings, I mean more money in your savings account.
In Part 1 of this series on saving money, we looked at the following:
- Why it’s so important. You can’t be financially secure without growing your savings.
- Where to start. Set the intention and start exploring ways to free up more cash to deposit into a savings account.
- A challenge. How much money can you save in the next eight weeks?
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.”
When we buy something at a reduced price, there’s a tendency to 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?
When are savings not savings?
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 and Jennifer.
Susan‘s twelve-year-old dryer was dying. 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’d saved $150.
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 checking 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.
“But,” 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, 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.
A defining moment
In order to understand why it matters to pull extra cash, or cash not spent, out of your checking account and park it in a Savings Account, 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.
The $800 isn’t necessarily 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 checking 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, whether that’s a Savings Account or an investment account (e.g. tax-sheltered investment accounts).
The benefits of separating
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.)
Which is the best Savings Account to use?
This one’s easy – choose whichever pays you the most in interest.
Typically, that means a High Interest Savings Account (HISA).
Although be careful: Just because an account calls itself a HISA doesn’t mean it actually pays a high rate of interest. ⚠️
Here’s what I’ve learned after scouring the offerings over the last couple of years:
Brick-and-mortar banks – like Canada’s Big 6 – typically do a terrible job of paying interest on savings accounts.
Some offer teaser rates, but the problem with these is that they don’t make sense over the long haul.
When you read the fine print – which, incidentally, is typically buried in a not-easy-to-find page online – you discover that after a few months, the interest rate tanks.
I’ve used EQBank and Oaken Financial HISAs, both inside and outside of TFSAs. They’ve been offering among the highest rates for savings accounts for ages now.
Bear in mind, though, that anything less than the rate of inflation means 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 pays you as much as possible.
One account or many?
This one’s entirely up to you. Whatever works best for you.
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.
One of my course students recently purchased a computer and booked a holiday using funds set aside in separate accounts for those purposes. Seeing the growing individual balances 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.
What’s in it for you?
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.
- An Emergency Fund provides a cushion when life happens. It also helps you to avoid taking on corrosive debt when times get tough.
- A healthy investment account gives you the opportunity to spend more time doing what you love with the people you love.
- A kids’ education fund helps your children get the educational opportunities they need to thrive.
- A travel fund provides much-needed fun, adventure, and joy without the strain of growing debt levels to pay for it all.
- Extra cash provides peace of mind. Imagine not having to worry about money by virtue of having a solid buffer in place.
Next steps
Here are a few suggestions for you:
1. 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.
2. 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 checking 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.
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