College funds. Retirement funds. Reserve funds.
At first glance, these accounts appear to all be different. But, they’re alike, too. Each one of them is dedicated to a specific purpose.
Many aspects of personal finance have to do with planning ahead. Such as deciding how you’ll spend to take care of today’s wants while saving for tomorrow’s needs.
Most people don’t have any issues with spending money. The problem lies in saving it!
But, saving money is essentially a way of planning to spend it at some point in the future. It may be on something that takes you by complete surprise or something you can see coming. And for those expenses you know are heading your way, you need to have reserve funds.
Nothing lasts forever. The products we buy have a useful life, but at some point, they’ll wear out and will need to get replaced.
Reserve funds are strategic savings accounts for the purchases you can anticipate making. You set them up by saving small amounts each month. Over time, you’ll have enough money set aside to pay for the items in cash. Otherwise, you’d get forced to come up with a large amount of money all at once.
For example, imagine you’ve just bought a used car. You know for certain the car won’t last forever, so you’ll need a plan to buy your next one. You determine the car will last for 5 years, so you start a reserve fund for it. Each month, you put money aside so that you can buy it without needing to dip into your savings, emergency fund, or sell assets!
Most people aren’t able to buy a big ticket item on a whim because they haven’t saved or prepared for it. So, they’re forced to take out debt and waste money on interest to obtain it.
Reserve funds are for the expenses you’re certain are coming and can predict. You know at some point your car will break down and you’ll need a new one. Just like the roof on your home is going to wear out and will need to get replaced at some point, too.
Reserve funds are for planned purchases, not emergencies. You have no idea when a financial crisis will strike, what it will entail, or how much it will cost. These events are unpredictable and the reason why you need a separate emergency fund to pay for them.
For example, imagine your car breaks down unexpectedly. You had no way of knowing it was going to happen. For these unforeseen events, you would use your emergency fund.
But, you wouldn’t use your emergency fund to buy new tires. You know tires only last for so long before they need replacing. This is an event you can foresee which means you would use your reserve funds to make the purchase.
Your savings account is also different from a reserve fund. It’s used for the investments you’re planning to make and the financial goals you dream of reaching. However, you can choose to keep your reserve funds in a savings account.
A cash runway differs from a reserve fund, too. The purpose of this account is to give you time and money to chase a major dream, like starting a business or taking an extended trip. You’ll still need reserve funds while you’re pursuing these things because the items you own will continue to wear out and need replacement.
I can’t lie, t takes financial discipline to keep your money in separate accounts and use them for their intended purpose. But, when you do, you’ll experience peace and a better sense of financial wellbeing!
Before you can start saving for something, you need to know what you’ll need to buy. First, determine what major item is going to wear out and gather the details about it. Next, compare it to the alternatives that are available and decide which one will fit your needs best.
Once you’ve decided what you’ll buy, you can estimate the amount it will cost. Begin by looking online to get an idea of the total amount that you’ll need. Don’t forget to include any hidden costs, too.
Also, see if there is a way you can get a better deal. Check your money calendar to see if the item will go on sale, or if it makes more sense to buy the item used, instead.
Next, you’ll need to figure out how long the item will last. Look at reviews and do some research to get a better idea of the product’s lifespan. This will help you determine its useful life, the amount of time you have left, and how soon you’ll need to replace it.
For purchases that are many months or years away, you may need a buffer. This is money in addition to the amount that you determined in Step 2. It accounts for factors outside your control. Things like, supply, demand, and inflation.
At this stage, you know how much you need and when you’re going to need it. Using these two factors, calculate the amount you need to save each month. Then, add this number to your monthly budget.
Reserve funds are for purchases that you’re going to have to make. They aren’t optional, nor can they be easily avoided. So, don’t invest these funds and risk them in the market. If you do and the market goes down, you may get left stressing to cover your shortfall.
Instead, keep your money someplace safe, like a HYSA. Consider opening an account at Ally Bank or Capital One 360. Both allow you to have multiple reserve funds all within the same bank account!
Things you need are going to break and you’re going to have to replace them. It’s not a matter of if, but of when.
Start building your reserve funds now. They’ll help you prepare and save for the expenses you know are coming. Not only will you have the money, you’ll also have the peace of mind that allows you to continue pursuing your dreams!
How many purchases do you have reserve funds for? Comment below.
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