Systematic Saving to Establish or Increase Cash Reserve

By August 26, 2020Article

What is systematic saving?

As its name implies, systematic saving is the process of saving a portion of income on a regular basis. It is important because establishing or increasing a cash reserve should be the first savings objective of a financial plan. Further, most people do not save on any systematic or regular basis, so the plan’s long-term success is likely to benefit from early development of this excellent habit.

Pay yourself first

For those who do not yet have financial security and independence, systematic saving and building a cash reserve are the first steps (managing debt is a close second, except in dire situations). You should look at systematic saving as paying yourself before you are tempted to spend it elsewhere. Money spent is money that usually must be replaced by working for it. As the adage goes, a penny saved is a penny earned.

 

The benefits of automatic savings

With an automatic savings plan, you formally arrange with an employer or financial institution to set aside periodically a specified amount of money from your income or an existing account. This is different from simply planning to save regularly on your own, which requires that you take action on your own to set aside the specified amount each time. Automatic plans are preferable because the transactions are made by others and the temptation to divert funds (out of sight, out of mind) is reduced. However, planning for periodic savings, which is often part of a budgeting process, is better than not saving at all, especially if the routine savings amount is viewed as a mandatory bill payment. Automatic savings also is more convenient, since it’s handled by others.

 

Automatic payroll savings plans

Today, many companies offer a payroll savings plan as an employee benefit. These plans automatically withhold an agreed-upon amount from each paycheck and deposit it in an account on behalf of the employee. The employee usually is free to start and stop the withholding process and to change the amount withheld, provided changes are within reason and according to the plan’s established guidelines.

 

Automatic account transfers

Most financial institutions offer depositors an opportunity to have funds automatically moved between accounts on a periodic basis. While not a savings plan as such, automatic transfers provide a convenient way to save, regardless of the objective. These plans tend to offer significant flexibility in starting, stopping, and altering the amount being transferred, plus a selection of several types of accounts.

Banks and credit unions–Many people keep a checking account and a savings account at the same institution, usually to capitalize on fee discounts and other benefits. In addition to basic savings and checking accounts, financial institutions also often offer money market deposit accounts. They also may have other types of term deposit accounts. Having multiple accounts at one institution can facilitate having a specified amount transferred periodically to an account you designate for cash reserve savings.

Jane arranged with her employer for the automatic deposit of her paycheck into her checking account at the ABC Bank. She now can request that the bank automatically transfer $500 each month to a money market deposit account that she also has set up as part of her cash reserve.

Brokerage firms–More and more, brokerage houses and large mutual fund companies offer accounts and services similar to those of banks (the reverse is also true). Consequently, you will often find opportunities for automatic payroll deposit and automatic account transfers outside of banks. If you hold investment securities with a brokerage, for example, you might arrange to have earnings from those securities automatically deposited to a money market mutual fund rather than automatically reinvesting the earnings. However, be aware that unlike bank accounts, these accounts do not qualify for insurance by the Federal Deposit Insurance Corp. (FDIC).

Don’t confuse a money market deposit account with a money market mutual fund; a money market fund–even one sold by a bank–also is not FDIC insured. It’s possible to experience a loss in a money market fund, though funds typically will go to great lengths to avoid letting their share price drop below the standard $1 per share. Obtain and read a fund’s prospectus (available from the fund) so you can find out about its investment objectives, risks, charges, and expenses, and consider them carefully before investing.

Be cautious of tax implications here. Tax laws change frequently.

 

Budgeting for regular savings

Whether or not you use formal budgeting to manage your financial activities, you can plan to contribute a specific sum regularly to your cash reserve. If you do use a budget, think of the amount you save as a regular expense, similar to other high-priority expenses.

 

Match your savings approach to your needs

When implementing a systematic saving plan, begin by selecting an approach that best matches your needs.

Jane’s bank offers money market deposit accounts whose interest rates are higher than those in her employer’s payroll savings plan. The deposit account’s minimum balance requirement of $2,000 is not a factor for Jane, so the bank option is her best choice.

You may find that you need a more aggressive approach to saving than a single-step approach can provide. You can increase your savings rate by adding a new approach to those already in place.

If the automatic savings that Jane arranged with her bank is insufficient to achieve her goal within her time frame, she can also arrange for dividends from stock shares she inherited to be automatically held in her account instead of being reinvested. She can then move these funds into her cash reserve once a significant sum has been accumulated.