I drive a 2001 Honda Accord. It’s a great little car. Right now, it has a little over 175,000 miles on it. Sooner or later (let’s hope, later) I’m going to need to buy a newer automobile. Here’s my process for saving for a car – or any other major purchase.
1. Using the super-handy You Need a Budget software, I create a budget category labeled: Automobile Replacement.
2. I estimate the number of months between now and my plan-to-purchase date.
3. I then estimate the cost of the replacement vehicle.
4. I divide the estimated cost by the estimated number of of months. This tells me how much I need to save, each month, to reach my savings goal.
In effect, I’ve created a monthly “payment”. Instead of paying the bank or the finance company – I’m paying myself.
I like to automate the process. I use our Ing Direct Savings Account to set up an automatic monthly withdrawal – for the “payment” amount. I deposit my paycheck in our local bank, the automatic withdrawal occurs a few days later, and I’m one month closer to reaching my goal.
Now, obviously, there are some things to consider:
First, it’s rather difficult to estimate the exact cost of a future purchase, especially a purchase that may be several months (or even years) down the road. My system (rather imperfect, but something to work with) is to find the average price of the automobile I want, today, and then add 5% to that price, for each year that I’ll be saving. If the car costs $10,000 today and I plan to purchase the “same” care in 3 years, my goal will be $11,500. Again, this is a very rough estimate and doesn’t take in to account compounding, but it’s a number to work with.
Second, it’s also difficult to tell just how much my current car will be worth, when it’s time to sell it or trade it. So, for me personally, I just leave it out of the equation. Why? I would rather over-save (is that a word?) than under-save. Plus, even if I buy something newer, I might just keep my little car. If I knew that the future price of my current car was going to be rather significant, I might consider that when creating my savings goal. As it stands, I’ll just save for the newer car – and decide at the time of the future purchase, whether to sell the old car or not.
Third, I might need a newer car before I’ve reached my savings goal. Again, it’s difficult to be in the prediction-game. My Accord is running quite well and gets me, comfortably, from place to place. Ten months from now, this might no longer be true. The goal is to be prepared, as much as I can, given the facts that I currently have before me. I cannot be (overly-) concerned about things that I cannot control. I prepare for a certain reality and adjust as needed.
Fourth, I really don’t worry too much about the interest rate that I’m getting on my savings. Right now (as you well know) – most rates are very low. In the past, like when I started this blog, it was fun to get 4 to 6 percent rates – and I would use them when calculating how much I’d have in x number of months. Now, I just focus on principal and consider any interest earned as a bonus.
By creating a monthly “payment” – to myself – I do two things. One, I am assured that I will reach my savings goal. Two, I keep myself from spending “extra” money on frivolous things. One of the distinct dangers, oddly associated with being consumer-debt free, is the fact that, without monthly obligations to creditors, it is easy to be wasteful. By creating a series of budget categories, under the heading of savings, an saving for specific things, every dollar has a name, every dollar has a purpose.
There is a side-benefit to saving for specific goals and specific purchases. We have savings categories labeled – Appliance Replacement, Furniture Replacement, Automobile Replacement, etc. Each category is funded, monthly. Once a category has been “fully-funded” – the money that was going into that category, is directed into another category. In effect, we are “snowballing” our savings goals – just like we did with our debt reduction. That 36-months goal might become a 30-months goal, or even a 24-months goal, depending on how quickly we fully-fund other categories.
One last note – We didn’t have savings categories until we paid off our last consumer debt. Instead, we used every penny (above our emergency fund) to pay off debt. The interest rates charged by our creditors were higher than the rate we could achieve in savings, so it made sense, mathematically and emotionally, to get out of debt.