The Savings Snowball

by Kevin on February 15, 2008

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Update: Get Rich Slowly linked to this post on February 20, 2009 — more than a year after I wrote it.

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If you are trying to get out of debt you may have heard of the debt snowball. Essentially, you line up all of your debts and put all of your spare money toward the one with the lowest balance. After that one is knocked out, you go after the next smallest one. And so on until you are debt free.

We are using this same method for our savings method. Here’s how it works for us. (BluntMoney has also described her method for snowballing savings.)

  1. Come up with a list of goals you want to save for. Some examples: funding a Roth IRA this year, having an emergency fund of 3-6 months expenses, or saving for a trip.
  2. List those goals in order of either importance or date you want to have completed. For example, you may want to completely fund your Roth IRA this year, but you are also going on a trip. The trip has a deadline, so maybe in this instance it gets first dibs on your saved money each month. This will differ from person to person.
  3. For each goal, there are two ways to determine how much you save each month. If the goal is ‘due’ by a certain date, then calculate the payment you need to make to yourself each month to reach the goal. If you want to save a specific amount each month, calculate how many months it will take you to get there.
  4. At the end of every month apply your free cash flow (what is left after income minus expenses) and apply to the goals in order.

Here is how our Savings Snowball is currently set up:

  1. Save $3,000 by the end of August 2008 for a trip to NYC this December. Payment: $200.
  2. Save $3,000 by the end of July 2009 to cover excess MBA school debt (my company is paying for about 66%). Payment: $80.
  3. Save $50 into our emergency fund. Payment: $50
  4. Save as much as possible into Roth IRAs for 2007 and 2008. Payment: Whatever is left of the savings money.

We wanted to fund the New York trip a few months ahead of time to give us time to react to the cost. If the things we decide to do come out to be $3,400, we have a few months to save up that extra cash. Based on what we had already saved up, a $200 payment would have us finish by late August. We rounded up because $200 is a lot easier to remember than an exact amount such as $194.13.

With my MBA loan debt (in deferral), payments don’t kick in until after I graduate. There may even be a grace period after graduation, but I wanted to have the money saved up. Again, I calculated how many months were between here and there and came to a rounded number of $80 per month.

We have a goal for our emergency fund as well. However, since we already have at least a month’s expenses saved up we didn’t think putting the rest of our money into it made sense. A payment of $50 from us (plus all of the interest in our accounts, which is roughly another $50) will get us on our way.

The rest of the money falls into the Roth IRAs.

Let’s say we get to the end of the month and have $800 left over to save. According to our plan, $330 is immediately broken up and placed in the above categories. This leaves us $670 to put into our Roth IRAs. It’s pretty simple, but can be powerful once you reach a goal (just like the debt snowball).

Once our trip is funded, we suddenly have $200 of extra cash flow to apply to the next goal — saving for my MBA loans. Instead of placing $80 per month aside, suddenly we are dropping $280 into that category. This accelerates how soon we reach this goal. After that is fully funded, we move to the emergency fund, and so on. Some people will say the debt snowball is completely different from this. Or say I am doing this all wrong. That’s fine, but this works for us. If this were truly like the debt snowball, every last cent we save would go toward the first goal, then the second goal, then the third. I guess I’ve got it set up in the way I do with specific payments sort of like minimum payments on debt. It seemed silly to us to save everything for a vacation, and nothing for retirement, debt, or emergency fund.

The bottom line is you need to have goals for how you save your money. You have a 100% chance of not hitting a goal you never set. Do the math and see how much you can set aside each month for your goals. The next thing you know you’ve saved for that next car, or the down payment on a house, or for that special anniversary trip.

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