Financial Reserve System
Managing Your Personal Finances: The Importance of a Savings System
Reading time: 7 minutes
Setting money aside isn’t always easy, as there often isn’t much left after covering your net expenses.
You might be one of the lucky guys who gets his pay slip every month, feeling great about the number on it.
After paying for fixed costs like rent, electricity, insurance, and subscriptions, as well as planned expenses like groceries and household items, you might even have some money left.
Sounds like a good starting point to save.
But then, tempting offers come up, your wardrobe could use an update as well and to make it even better - your car suddenly needs repairs.
By the end of the month, there’s nothing left.
When it comes to unexpected expenses, such as car repairs, it’s very uncomfortable if there’s no money available to cover the costs.
This is where a savings system comes in handy, where you set aside money for various possible future expenses, so you don’t end up in financial trouble.
It also provides mental freedom because you won’t worry when unexpected costs arise. While it’s still unpleasant to “lose” the money, at least you planned and prepared for it. This helps relieve the pressure.
There are many approaches to implementing such a savings system. I’ll present my method, how I organize myself, and what you need to copy it.
First, calculate your net income.
Calculating your Net Income
Your net income is the basis of what you have available after deducting your fixed and planned variable costs.
Let’s assume you receive your salary and/or other income at the beginning of the month. Additionally, you pay for rent, electricity, garbage fees, internet, and other expenses that go out at the beginning of the month.
Also, consider that you probably have ongoing costs throughout the month, such as a Spotify subscription or a gym membership. These are all fixed costs that shorten your available income.
You should also calculate your monthly variable costs.
This doesn’t have to be precise, because the expanses may vary (variable - got it?), but you can estimate based on the average of previous months.
For example, if you plan €300 per month for groceries, you’re averaging €10 a day.
Do this calculation for all your expected expenses.
If in doubt, round up to ensure you’re covered. It’s important to plan as many expenses as possible.
There will always be some unexpected expenses or variations over the months, but the more accurately you can predict your costs, the better your savings system will work.
How to keep track of your finances with a financial planner, looking at both the past and future, will be explained in a separate post.
This is a powerful tool and will help you track your expenses better and plan long-term and securely for the future.
Next, define your savings categories.
After determining your monthly expenses, you’ll know what you have left to save.
But what do you do with the money?
The goal is not to simply set aside what’s left at the end of the month – in that case, you wouldn’t need a savings system.
In this step, consider what you want to save for.
This can include short-term, medium-term, and long-term goals.
If you want to buy new clothes every quarter, that’s a short-term savings goal.
If you plan to buy a new iPhone every 2 years, that’s a medium-term savings goal.
Saving for a house is a long-term goal.
I don’t categorize savings this way; this is just to help you determine the timeline you’re planning for.
This will also be relevant later when deciding on the investment model.
Think in categories, grouping related expenses thematically. Here’s an example of my defined categories:
🚘 Car Savings:
In the car savings category, I combine various cost types. I know I need to pay for car insurance once a year, need new tires about every two years, and that various repairs are likely.
So, I set aside a total amount that covers these costs. This doesn’t include costs like fuel or car washes, which are part of the variable costs already deducted.🪴 Housing:
In this category, I primarily set aside money for furniture, appliances, and repairs. I don’t know when, but eventually, I’ll need a new sofa, washing machine, or vacuum cleaner.⛱️ Leisure and Travel:
Here, you can set aside funds for outings and small trips, as well as save for your next annual vacation. I set aside a smaller amount for monthly outings and a larger amount for the big vacation.📱Personal Savings:
This category is perhaps the broadest. You can include anything that comes to mind, such as the iPhone you want to buy every four years or the clothes you regularly treat yourself to.
💸 Long-Term Savings:
You may have heard that it’s best to have three months’ worth of net income set aside to cover extended illness or short-term unemployment.
This is part of what I save here.
You can also save for retirement or your home equity. However, for these forms of savings, I recommend other investment options than simple savings accounts, which I’ll discuss later.
As you can see, I only set aside money for expenses that aren’t part of my monthly standard expenses.
I don’t create separate savings for individual items, such as one for new clothes and another for the new phone.
The total in these savings should ideally grow over time beyond your expenses, allowing you to build a financial buffer that can cover larger costs.
This is an iterative process, and you should continually review whether to add another category or if you have too many.
The same goes for the amount you save and the amount you set aside each month.
Your budget determines the amount of your savings.
Once you’ve set your categories, you can decide how much to allocate to each.
Again, the goal is not to save what’s left at the end of the month but to save directly from the amount left after calculating your net income.
First, calculate the savings for necessary expenses, such as housing, car, and emergency funds.
Plan a little extra to be safe.
Initially, this might feel restrictive since you’ll have less left for other categories after covering essential ones.
But it’s freeing when your transmission fails, and you don’t have to worry about paying the €1500 repair bill - believe me!
Of course, align your savings with your financial situation and try to cover as many categories as possible. As mentioned, this is an iterative process, allowing constant adjustments.
How to calculate the savings amount
Much can be planned using the depreciation principle. You might be familiar with depreciation, where it’s about accounting for the loss of value or replacement of an asset, especially in business accounting.
Imagine buying a car, sofa, or TV.
You don’t know when these items will need replacing, but you can estimate their typical lifespan.
A sofa, for example, lasts between five and fifteen years depending on quality and use; a car often needs significant repairs after 150,000 kilometers, and by 200,000 kilometers, it’s usually time for a “new” one.
Based on these estimates, you can decide how much to save for a replacement.
If you buy a sofa for €1500 and expect it to last eight years, save €15 per month (€1500/8/12).
For your new iPhone every 4 years, it’s €18.75 per month (€900/4/12).
A “new” car for 10k every ten years will need €83.33 (€10,000/10/12).
Don’t forget savings for repairs. For example car repairs.
General car repairs come in addition to savings for a “new” one.
The calculation might be: €500 each year - that’s what my average was - so €41.66 each month (€500/12).
Use your experience or research to estimate how often repairs occur and how much these repairs cost.
Plan for a buffer and round up.
If you eventually save too much, you can always reallocate the funds.
After defining categories and budgets, it’s time to start saving.
There are various methods for saving. You could mentally set aside an amount each month, but that might not be reliable, especially with many categories.
Besides, this would defeat the purpose of the savings system, which is to show you what you can afford and provide mental freedom.
Mental accounting doesn’t achieve this.
Some people withdraw the calculated savings as cash and store it in labeled envelopes. This is possible, especially if you don’t trust banks.
However, digital accounts are more flexible, organized, and straightforward. I use multiple banks for different accounts.
One for long-term savings, another for personal savings, and yet another, my main bank, for the rest of my accounts.
My main bank, where my salary is deposited, allows me to create sub-accounts that I can name according to my savings categories.
I recommend DKB, an online-only bank with excellent service and features.
N26 is also notable, with beautifully implemented sub-accounts called “Spaces,” as well as automated tools that show a forecast of all your accounts. But this requires a paid subscription.
The type of account matters.
As you may have already thought, it's best not to let your money just sit around and lose value until it's needed.
It has been relatively difficult to earn interest on savings, but this is starting to change, so it's important to stay informed.
For my short-term reserves, where there is more frequent movement, I have yet to find a worthwhile account, as these often require committing to fixed terms.
However, for long-term reserves for emergencies, a fixed-term account might be more beneficial, as you ideally won’t need to access this money.
It's crucial, though, to ensure that you can access the account relatively easily, as you don’t want to face penalties if you need to use the money in an emergency.
If you want to build a truly long-term reserve, like a private retirement account, I recommend other investments as mentioned above.
Life insurance or Riester pensions are no longer profitable, but for such purposes, you can effectively invest your reserve in the stock market.
This way, you save a certain amount every month, and over time, your money grows through the reinvestment of dividends. I'll explain more about this in a future article.
Quick tip: when checking my total balance, I don’t take my stocks into account. This is for two reasons:
My stocks are my long-term savings for when I am even older than I am now.
The value of stocks fluctuates. Therefore, I don't want to plan with a calculated amount.
Which type of account is best suited for you and your needs is something you'll need to determine for yourself.
However, with various reserve accounts, you are well-protected against unforeseen expenses. The best part is that you always know what you can afford.
Discipline is crucial.
The whole system only works if you discipline yourself to build your reserves consistently and avoid using the saved money for unrelated purposes.
It’s pointless to set aside a substantial car reserve with good intentions, only to dip into it for a new bicycle because you don’t have enough funds.
As fate would have it, that's exactly when a major car repair might be needed, leaving you scrambling to find the money elsewhere.
The same principle applies to making contributions to your reserve.
If you’re not serious about saving and, for example, decide to put aside €20 for a new sofa but end up spending that money because you want a new iPhone sooner, you undermine the whole purpose of the reserve.
Once you start repurposing your reserves, you risk falling into a pattern that’s hard to break.
Of course, your financial situation plays a role as well.
There may be times when you can't save as much as you intended, or an unexpected event occurs that you hadn't planned for.
Or perhaps the car repair is so costly that you have no choice but to tap into another reserve.
If this happens, you should prioritize replenishing your reserves as soon as possible, perhaps using a bonus like holiday pay.
Here’s another tip: when you receive a raise or a bonus, don’t immediately adjust your lifestyle or splurge.
Instead, increase your contributions to your reserves.
Set up automatic transfers to aid discipline.
To consistently build your reserve accounts, it’s best to automate the process.
Set up standing orders that automatically transfer the designated savings amount from your main account to each reserve account at the beginning of the month.
This is where the benefit of sub-accounts in your banking setup comes into play.
Automating your savings relieves you of the pressure to remember each transfer and prevents you from changing your mind. When the money is moved directly from your main account, it's "out of sight, out of mind," reducing the temptation to spend it "accidentally."
Although you can still access the funds for other purposes or transfer them back, the automation adds an extra hurdle, helping you stay disciplined.
As mentioned, I apply a similar approach to my investment portfolio. Once the money is invested, I no longer consider it liquid funds that I can use for everyday purchases.
This mindset makes it mentally easier to treat your reserves as untouchable and avoids the feeling of having a large sum of money readily available for discretionary spending.
Use a financial planner to monitor your accounts.
A financial planner helps you track your savings over time. Whether it’s an app or a spreadsheet, it helps monitor account balances, expenses, and income, enabling better long-term planning.
I’ve used my system for over ten years and can predict my account balances with great accuracy over a five-year period (and longer for my long-term savings), allowing for better financial security and planning.
The more meticulously you manage your reserve system and the better you can predict your income and expenses, the more accurately you can forecast how your accounts will develop over time.
A separate post will cover this in detail, where I’ll delve into the financial planner and explore the various tools available to help you track your finances effectively.
Send me a message if you are interested in my template.
Finance Planner
I have been using my system for over ten years, and I've been able to make highly accurate predictions about how my accounts will develop, with only a few hundred euros of variance over a five-year period.
Ultimately, this approach offers two key advantages:
You always have a clear view of where you stand financially and what you can afford to spend. This provides a sense of security and reduces mental stress.
By being able to forecast your financial future, you can adjust your needs and financial capabilities today, knowing what you can afford in the future.
This not only motivates you but also provides additional mental security and peace of mind.
Regularly review your expenses.
What I mean is that you should regularly evaluate whether your monthly expenses are truly necessary.
Perhaps you subscribed to a service months ago that you no longer use or don't use as much as you initially thought. In that case, consider canceling the subscription or switching to a more affordable plan.
If your variable expenses have increased over the past weeks or months, examine your spending habits in those areas, such as groceries.
Have you been buying more expensive food or indulging in snacks and drinks that aren't particularly healthy?
While this may seem logical, it's often overlooked or not recognized. Over time, these small amounts can add up to a significant sum that could have been better saved for something like your next vacation.
Enjoy and succeed in setting up your savings system.
What do you think about the savings system? Have you tried something similar? What were your experiences?
Share your thoughts and experiences in the comments.
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