Like Rodney Dangerfield, savings accounts don’t get any respect. In a world dominated by exchange traded funds, tax-sheltered retirement plans, and low interest credit cards, savings accounts are kind of dull.
But for all of their lack of excitement, savings accounts fill a fundamental role in your overall financial plan. Savings accounts can keep you out of debt, and here’s how they do it.
Spending out of your savings, rather than your credit cards
People get into debt largely because of a bad habit they adopt early in life: they learn to spend out of their credit cards. This is especially true when you’re young, and income is low but expenses are high. You buy what you need and want, even if your paycheck doesn’t cover it, and you do it with revolving debt.
This might be okay if it only happens when you’re young and you begin to shift gears as you get a little bit older. But once it becomes a habit it turns into the way you transact business. You can also reach a point your debt levels become sufficiently high that you lack the means to change the pattern. Because so much of your income is taken up by debt repayment, you have little choice but to continue paying by credit card in order to pay your bills.
Having a savings account is the best way out of that trap. Once you have a few thousand dollars put away you can begin living out of your savings rather than your credit cards. Instead of using plastic to pay your living expenses, you begin transferring money from your savings account. The shift in reliance on your savings account replaces your dependence on credit cards.
Keeping you covered in an emergency
If you don’t have a savings account, you’re probably using credit cards in lieu of emergency savings. And if you have a substantial amount of credit card debt, you are probably experiencing more than the usual number of emergencies.
Since credit card payments can eat up a lot of income, financial emergencies are caused by a simple lack of sufficient income to cover expenses. At the extreme, the end of every month could turn into some degree of an emergency. It may be $100, $500 or $1,000, but because of your credit card payments, you’re short every month. As the credit card balances build, so to the emergencies.
If you have a healthy savings account balance, you have a ready source of funds to cover emergencies. And in all likelihood, you will probably have fewer emergencies. Continue Reading →