The Three-Account System That Protects Your Savings

You may be familiar with this pitfall. You have been saving money in a big reserve and something breaks (your water heater). You take the funds, tell yourself you’ll replace them soon, and before long, you’re using those dollars for your car repairs, reducing your emergency fund by half. It isn’t that you can’t control how much money you spend; it’s just that your money doesn’t sit in separate pools. So, each dollar sitting in that pool appears as an option to use on almost anything. This “mixing” causes significant problems after age 50, when income tends to steady out but expenses get lumpier.

There’s a very simple way to avoid this problem. Create three separate savings accounts and assign each one a specific task. This is how the system works and how you’ll set it up this week:

Account 1: Your real emergency fund (the money you don’t touch)

This is your safety net, designed to last during periods of unemployment, unexpected medical expenses, or times when you cannot work. Consider creating three to six months worth of your basic living expenses. If your basic monthly spending (housing, food, insurance, utilities, medication) is $3500, consider saving between $10,500 and $21,000. Save this money in a high-yield savings account. A high-yield savings account is just a regular savings account that pays a much higher interest rate. Big national banks usually pay next to nothing, while many online banks and credit unions pay far more on the same federally insured deposits. The difference in earnings potential could be hundreds of dollars per year on $15,000, money earned without doing anything.

Only take money from this account in case of a true emergency. While a new roof may not be considered an emergency, a sudden visit to the hospital certainly is. Keeping it separate makes that call easier.

True emergency: Lost employment, unforeseen medical bill, necessary repairs to make your home safe immediately. Not an emergency: Holidays, a planned trip, repairs you knew were coming.

Account 2: Money for the bills you can see coming

A sinking fund is an old, plain idea: you set aside a little each month toward a known expense so the bill doesn’t catch you off guard. Besides car maintenance (new tires run about $800), you likely have home maintenance (about $1,800 a year), vacations (about $2,500), and a $1,200 insurance premium that hits twice a year. To figure out how much to save each month for these expenses divide the estimated total cost by the number of months until the expense occurs. For example, if you expect to replace your car tires in 24 months (2 years) and they cost $800, you would divide $800 by 24 months and begin saving $33 a month towards that expense. Once the tires are replaced, you can replenish that account and continue saving.

Many online banks let you create multiple sub-accounts for free, so you can name them Car, Home, Travel, and so on. If yours doesn’t, a simple note tracking each chunk inside your main account works just as well. The goal here is that this money has clearly been designated for those expenses so it should never be confused with Account 1.

Account 3: Long-term savings and money for opportunities

This is the money used for larger financial goals that aren’t necessarily tied to emergencies or known expenses. This is where you keep money reserved for the big fuzzy things and the unknowns, moving to a different city in a couple years, paying for a medical issue that Medicare won’t entirely cover, a business opportunity that requires cash to act quickly on, or helping a grandchild with college. This is also where you let your savings grow beyond the 6-month mark without having to constantly worry about whether you have access to the money or not. Consider putting this type of money into a high-yield savings account as well since you anticipate needing it within 2-5 years. If you are looking further down the road (more than 5 years), you can discuss investment options with an advisor regarding this portion of your savings.

Consider thinking of this account as “breathing space.” With this account established, you will begin making financial decisions based upon possibility and freedom rather than fear of losing your money elsewhere.

Three accounts vs. one big pool

In addition to having actual labels on bank accounts, we also use psychological labels when thinking about money. So, a dollar in a labeled “Emergency” savings account may feel as though it’s been earmarked for emergencies (and so would be difficult to spend), whereas a dollar in a labeled “Travel” savings account may seem like free money to spend on travel, even if the two dollars cost the same. Researchers call this system of labeling and separating money into separate groups, mental accounting. Using this system will help you create barriers to impulse purchases. When your entire balance sits in one group or pool, your mind quietly runs the math, as in “I have $30,000 and so I could afford $4,000 for my kitchen.” However, when you split your balance into individual labeled accounts (“Kitchen Savings”, “Vacation Savings”, etc.) and your Emergency Fund sits in yet another separate fund or account, that quiet math stops, and you can see at a glance which funds are available to you and which aren’t. Separating each portion of your money into individual accounts creates an additional layer of separation from making an impulse purchase because transferring money from your Emergency Fund requires you to make a thoughtful decision (moving money out of an Emergency Fund takes a deliberate action). That single moment of pause can prevent unnecessary transfers.

Let automation run it so you never need willpower again

Your best shot at a savings system that sticks is one that needs no thought at all. Figure out when your paycheck or Social Security lands, and set up automatic transfers into each account for the day after. Because the money moves before you ever see it, you never feel like you’re going without.

If you need to start small, don’t worry! Start with small contributions, e.g., $50 to your emergency fund, $100 divided among your Sinking Funds (e.g., car, vacation, home), and $25 into opportunity fund. These amounts will establish the behavioral patterns required to maintain these accounts. As time goes on, increase the amounts transferred into each of the accounts as desired.

Most high-yield banks let you set up multiple named sub-accounts for free, so open one (or three) at an online bank or credit union, all FDIC or NCUA insured. Then set the automatic transfers as described above.

Label each account clearly, so its purpose is obvious when you log in.

Fill the emergency fund first, then the sinking funds for your two or three biggest yearly expenses. The opportunity fund comes last.

What to do this week

Do not attempt to implement all three accounts simultaneously. First, open one high-yield savings account labeled Emergency, move as much as you can into it, and set up automatic transfers. That one action will protect you better than any budget or spreadsheet will.

Next week, set up automatic transfers into sinking funds for two or three of your biggest yearly expenses. The opportunity fund can wait until the first two are running.

Within a month or two, you’ll have a system that runs while you get on with your life, and the next broken water heater will be an inconvenience instead of a disaster.

Photo by Nick Fewings on Unsplash