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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.
Helping you to pay off old debt by not adding new debt
One of the underappreciated aspects of having and living out of a savings account, is that you won't be adding any new debt. That's the first step toward getting out of debt!
It does you little good to pay down your credit cards at the beginning of the month, only to run them up again at the end of the month. This is the kind of cycle that can make getting out of debt seem impossible. And if that's how your finances work, it really will be impossible. That's the very nature of revolving debt – credit in, credit out, and it never goes away.
Even with credit cards, if you stop borrowing money and faithfully make your monthly payments, eventually the cards will be paid off. That can only happen if you stop using them adding new debt. You can do that if you have a healthy and active savings account.
Savings create an orientation toward thrift
Yet another silent feature of a savings account is that having one, or more specifically creating one, requires that you live beneath your means. In order to do it you will have to develop an orientation toward thrift.
That may mean avoiding certain purchases or activities that aren't absolutely necessary, or finding ways to do and to buy what you want for less money. When you learn to live on less than you earn, you create the margin that you need to fund your savings account – and to make all kinds of other good things happen in your life.
Since it's borrowed money, credit cards often encourage us to do the opposite – to spend more than we can afford. That's never a healthy path to be on, and having a savings account can get you off of it.
Savings build the foundation for investing
When you become oriented toward saving – rather than borrowing – you eventually build up a level of savings that's greater than your immediate need for cash. Once you do, you will have the money needed for investing, which has the potential to increase both your assets and your income.
In the process, you cross the line from being a debtor, to being an investor. As a debtor you live on borrowed money, and your net worth may even be negative. As an investor, your assets grow, pass your debts, and you have a positive net worth that can grow to be as large as you can imagine. And you no longer need credit!
That whole exciting process starts with a savings account. You start with a small amount of money saved, build up steadily, learn to rely on it rather than on credit cards, and eventually all kinds of other options open up.
If you're having difficulty with credit cards and other kinds of debt, the answer to your problem to be no more complicated than a simple savings account. Boring, maybe. Effective, definitely!
Sometimes the simplest solutions are the best.
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