Last night, I was at a party for several homes in our neighborhood and I had a long conversation with a couple who were completely intrigued by The Simple Dollar. They asked me a lot of questions about it, and also asked a few personal finance questions. The one that really piqued my interest was when the female in the couple mentioned that she had started a savings account for her infant son in his name, was putting $5 a week in it, and was going to continue doing that until his 21st birthday, upon which they would tell him about the account. They started the account the day he was born.

I was intrigued by this, so I went home and did the math on it and a few other account ideas. If you put $5 away each week from your child’s birth to his 21st birthday into an HSBC account that earns 5.05% APY, your child would have $9,441.68 on their 21st birthday. If you put $10 away each week, the child would have $18,883.35. I also considered continuing until the child was 25 in order to spur on a down payment; if you did that at $10 a week, the account would have $25,185.81 in it.

Is the savings account too little? Each year, roll the account into an index fund. If it returns 8% a year (a low estimate), you’ll be doing even better ($10 a week until age 25 would yield $38,952.16). It’s rather clear that given the large period of time, you really give compound interest a chance to work.

Why do this? If I suddenly had $38,952.16 drop on my lap at age 25, I would have immediately had enough for a down payment on a home. We would not have spent years in a very tiny apartment – we could have moved on to a wonderful home earlier than we did. On the other hand, if I had that kind of money dropped on me before my financial meltdown, I’m not entirely sure I would have been mature enough to handle it. Ideally, I would think that I would have used it to pay off my debts, but I’m honestly not entirely sure about that.

Another aspect of the question is what financial support do you feel appropriate giving to your children? Once I turned eighteen, my parents gave me very little financial support – they assisted with textbooks the first semester or two, but after that, it was entirely up to me. I know other families, though, with children in their late twenties who still rely on their parents for many necessities of life. Doing this is in some ways actively choosing to not cut the cord.

When your child is born, one of the first questions you’ll ask yourself is how do I take care of this child over the long haul? A straightforward investment like a savings account might be an appropriate choice for you.

In the aftermath of yesterday’s discussion about how to manage several funds in one account, several people mentioned actually opening multiple savings accounts at ING Direct under one general account, enabling people to sort their money (I happen to be a big fan of ING Direct, but you may also want to read the note at the bottom). This, of course, intrigued others, who asked how this could be done, so here’s a description.

Step 1: Log in to your ING account Enter your information and go view your overall account information.

Step 2: In the upper left, click on the “Open Account” option You can see it clearly in the picture above.

Step 3: Choose to open a new savings account on the next screen The “Open Now” link in the image above is where you should go.

From there, the process is really straightforward – you can call each account you create whatever nickname you like to identify it as a distinct fund: an emergency fund, a “house maintenance fund,” a “vehicle replacement” fund, and so on. From there, you really should set up automatic deposits into each of these funds so that you can always be building up these funds.

Why not do this instead of using Excel? In fact, I did do this for quite a while. I moved my primary savings out of ING Direct not too long ago, not because of the service, but because having all my savings accounts so easily available made them tempting. (note: I later moved everything back to ING because of HSBC troubles). I moved the savings accounts to a single HSBC Direct account, and I manage the distinct layers in Excel. I’ve actually left all of my old accounts in place in ING and when I’m ready to get money from HSBC into a particular fund, I withdraw it from HSBC directly into the matching ING account, so I can quickly see when that money’s there and ready to go.

Having lived in a house that needed constant upkeep when I was young, I know the value of having money on hand to take care of home maintenance. As a new homeowner, that means I’m going to christen a home maintenance and improvement fund so that when such issues appear, I can handle them.

What’s a home maintenance fund? A home maintenance fund pays for the continual maintenance of things that we have right now. This includes things like pest spraying, weatherproofing the deck, having the chimney swept, replacing furnace and air filters, replace worn-out carpets, and so on.

How much will that cost? I’ve heard various recommendations, but we’ve settled on putting away 1% of the assessed value of the house and land annually into the account for home maintenance. This means that an amount equal to 1/12th of 1% will be pulled out of our primary checking each month into that account (for a $200,000 house, that means $166 a month), and then when home maintenance issues occur, we’re free to tap that fund to get the lawnmower fixed or replaced, to buy sealant, and so on.

OK, what’s a home improvement fund? Over time, we’re going to want to upgrade a few things around the house. We haven’t even moved in yet and my wife is talking about planting a small row of fruit trees along the farm-facing edge of our property, for example. Things like this are things that don’t currently exist but can improve the value of the property over time. We want to plant two apple trees and two cherry trees, and if we care for them properly and guide them to adulthood, they’ll increase the value of the home. Another topic we’ve talked about is installing quartz countertops in the kitchen.

We also want a home improvement fund so we can avoid home equity loans, a strategy I talked about last week.

How much will that cost? We estimate that improvements will likely be more expensive than maintenance, so we’re going to sock away 2% of the assessed value of the house and land annually into that same account for home improvements. This means an amount equal to 1/6th of 1% will be pulled out of our primary checking each month (for a $200,000 house, that means $333 a month). This is pretty high, we think, but it does enable us to start thinking and planning home improvement projects and knowing that we’ll be able to pay for them when we decide what to do.

It seems expensive now, but if we look at this as just another bill to pay, it will lead us to success in the long run.

As I’ve mentioned on here a few times before, I’ve been trying out the Volumetrics weight control plan in an attempt to lose a few pounds. So far, it’s been working quite well, but what I found to be quite interesting is that it really exposed one of my worst daily splurges – and now I can see both the health and the financial aspects of kicking this little routine.

See that little Snickers bar wrapper over there? It was my addiction. For years. I would eat one in the morning and one in the afternoon out of the vending machine at work. Seventy five cents a pop, making it cost a dollar fifty a day. Most days, this would literally just come out of pocket change, so it never really felt like a big expenditure, plus I was often quite happy to have that mid-morning and mid-afternoon energy rush that the bar would provide.

When I started Volumetrics, I started looking carefully at the nutrition labels on different items and the Snickers bar made me almost jump out of my skin. Wow! That candy bar alone was worse for me than almost any meal I would eat. I realized that for health reasons I needed to kick the habit, and I knew in the back of my head that it would help financially, too, but I was really worried about that mid-morning and mid-afternoon energy rush.

What did I do instead? Fruits, and a variety of them. I kept high-energy fruits on my desk: grapefruits, oranges, and bananas, mostly, picked up at the store for less than a quarter a pop. I’d eat one in the mid-morning and one in the mid-afternoon as an energy booster and it matched well with Volumetrics, too. I missed the Snicker’s bar, of course, but the routine of a banana in the morning and an orange or a grapefruit in the afternoon quickly replaced it – I didn’t even think about it any more after a couple of weeks.

I was spending a dollar less each weekday, so after five weeks I had lost a bit of weight, which was a nice reward itself. Not surprising to anyone, though, I decided to run the numbers to see how the saving was going. The math here is simple – five weeks of saving a dollar a day means $25 I didn’t have before. If I contributed that $5 a week to my daughter’s 529 account and it returned 10% a year, on her eighteenth birthday the account would have $12,200 in it.

$12,200 for college and a smaller stomach. I think my daughter would be proud of her dad.

Not all that long ago, if I wanted to spend money, I’d look at what was left in my checking account and spend it. I knew in the back of my mind that I should be saving some money, but I never looked at it as a requirement at all. It took me a while to grasp the idea of an emergency fund and that saving up for big purchases is a huge money saver.

To a degree, this even continued after my financial meltdown. I focused strongly on debt repayment at first, knocking out my credit card debts, but not really saving anything at all. I still hadn’t really grasped how to make it work for me.

It finally clicked one day when I overheard an elderly neighbor talking about paying her bills on her phone to her niece. She said that she had to write a check to the bank to put into savings, including it as part of her monthly bill routine. It seemed so simple and obvious, yet I had just completely overlooked it. Here’s what I did to get started.

First, I set up a savings account at a different bank than my primary checking account. At the time, I set up a savings account at ING Direct – it was easy to set up and had a good interest rate.

As soon as the account was ready to go, I immediately began to treat deposits there as another regular bill. I paid most of my bills online already with online bill pay, so I just added a regular contribution to the savings account to the pile of bills. I actually set it up so that I made a contribution this way and there were small additional contributions pulled out of my checking account on a weekly basis ($20 a pop).

Treating it as a bill and at least partially making it automatic made it much easier for me to start actually saving money. At that early stage, I didn’t worry about the idea of an emergency fund or a car fund – I just focused on the idea of building up cash in savings so that my future me would have something to fall back on.

As time went on and this became completely routine, I began to refine my strategy, but I still just treat contributions to savings accounts and investments as regular bills.

What’s the net effect? The biggest effect is that I’m not left with all that much money “floating” from paycheck to paycheck. Most of my money is used to pay a bill, whether it’s a “real” bill or just a savings or investment contribution. The second effect is that I know my savings and investments are growing and I know that if something happened now, I would have lots of cash tucked away. This literally makes me sleep better at night knowing things are secure.

If you’re having trouble saving, try setting up an account at a new bank and then putting in a contribution every time you pay the bills – treat thins contribution as another bill. Then, when you’re tempted to spend what’s left in your checking account, that cash won’t be there to tempt you to make bad decisions.

A couple years ago, an extremely influential article entitled A Simpler Way To Save: The 60% Solution popped up on MSN Money. It proposed a very simple way to budget:

After analyzing our spending patterns over the past couple of years using our Microsoft Money data file, I determined that we needed to keep our committed expenses at or below 60% of our gross income to come out ahead at the end of the month.

Committed expenses:
* Basic food and clothing needs.
* Essential household expenses.
* Insurance premiums.
* Charitable contributions.
* All of our bills — even such non-essentials as our satellite TV service.
* ALL of our taxes.

I’m not saying that 60% is a magic number. It’s a workable goal for my family, and it’s a nice round number. But your number might well be a bit higher or lower. At any rate, it’s a good place to start.

Then I divided up the remaining 40% into four chunks of 10% each, listed here in order of priority:

Retirement savings: consisting entirely of my 401(k) contribution, which is subtracted automatically from my paycheck.

Long-term savings: also automatically deducted from my pay to buy Microsoft stock at a discount as part of an unusual stock-purchase program. The relative lack of liquidity (i.e. the difficulty of turning these shares into cash) makes it harder to spend this money without some planning and a series of deliberate steps. In a real emergency, though, I could sell and have the cash wired into my bank account within three days, so this is also our emergency fund.

Short-term savings for irregular expenses: which are direct-deposited from my paycheck into a credit union savings account. Money in this account can be easily transferred into our checking account, as needed, via the Web. Over the course of a year, I expect to use all of this money to pay for vacations, repairs, new appliances, holiday gifts and other irregular but more or less predictable expenses.

Fun money: which we can spend on anything we like during the month, so long as the total doesn’t exceed 10% of my income.

So, they spend 60% of their income each month on required expenses (food, house, taxes, etc.), sock 10% away into a 401(k), sock another 20% away into long term and short term savings, and spend the other 10% on fun stuff. This general framework became so popular that it has been incorporated into recent versions of Microsoft Money, making it easy for people to organize their finances using this model.

I basically feel that this is a fantastic framework for people who are trying to get their money straight but have no idea where to start. A few little caveats, though:

60% is a baseline, not a hard and fast rule. If you dive in, I suggest starting with 60% and seeing how it goes. If you actually find it easy, try some frugal things and see if you can turn it into the 50% solution (and kick that extra 10% into savings); if it’s extremely difficult, make it a 65% solution for a while.

Frugality helps. Being frugal cuts down on that 60%, making it easier for you to reach that target or, even better, enable you to beat it. Doing things like installing CFLs instead of incandescent bulbs and practicing good shopping habits simply shave money off of what you owe every single month, resulting in some serious breathing room.

The short term savings is basically an emergency fund. As I’ve mentioned before, an emergency fund is one of the best assets you can have because it can earn at a solid rate, plus protect you from going into debt when the inevitable happens. If you don’t have one and are thinking of diving into the 60% solution, I would redirect some of the long term savings into short term savings until you reach a pretty solid number for your emergency fund. Personally, I’m shooting for eighteen months’ worth of emergency fund as soon as I can manage it – a very large emergency fund is personally important to me.

Don’t beat yourself up if you try it and at first don’t succeed. This is true for any personal finance goal, because such goals are a lot like diets: people set very difficult goals right off the bat, fail to reach them, and thus use that as an excuse to fall back on bad habits.

Today, I stumbled across a very interesting tool at the New York Times website that attempts to place you in one of five socioeconomic groups (upper fifth, upper middle class, middle class, lower middle class, bottom fifth) based on a number of factors (occupation, education, income, and wealth). I’m quite happy to share my results with you:

Occupation My primary occupation and side businesses all place me in the upper middle class range.

Education I received a bachelor’s degree, which puts me in the “top fifth.”

Income I used our whole household income estimate for 2007, which includes my primary employment, my wife’s primary employment, and income from my side businesses and investments. This puts us just in the “top fifth.”

Wealth Because we’re just now digging out of some stupid financial decisions, we are decidedly in the middle class range for wealth.

Average Overall, this tool identifies my family as being “upper middle class,” even though our wealth is decidedly “middle class” at this point. I would conclude that our other socioeconomic factors (our job, our education, and our income) all indicate that our wealth should move into the upper middle class range as our life goes on and perhaps even into the “top fifth” range and thus the tool has a bit of an age bias (it’s hard for young people to have accumulated the wealth that is identified as “top fifth” unless your last name is Rockefeller or something).

What else can we learn from this tool?

Education is a major key to upward mobility Assuming that education plays a significant role in class mobility as indicated in this article, the best way you can position yourself to move up in class is by working hard and getting an education. Completing a bachelor’s degree puts you in the top fifth in education simply because only 9% of Americans actually manage to acquire one. So, get an education.

Jobs that require you to use your mind generally have more prestige than manual labor jobs This isn’t surprising, but intellectually challenging jobs populate the upper third of the job prestige list, while physical labor jobs populate the bottom (craftspeople are somewhere in the middle). If you feel you only have the skills for physical labor, one potential way to move up is to look at a trade that mixes physical labor with basic problem solving, like carpentry, plumbing, electrical work, and so on. If you’ve got such a job and are looking to move up, it will likely require getting more education. In short, always work to improve yourself by learning new skills.

There is some age bias here As I mentioned above, younger people are inherently hamstrung by the wealth column, as most of us twenty and thirtysomethings are dealing with a very large debt load and not that many years in the workplace building up our wealth. In other words, the longer you’ve been earning money and not spending more than you earn, the more likely you are to be moving up in class due to the net worth bias.

This tool lays out exactly how to get ahead in America: get an education, constantly look for ways to improve yourself and aim upwards, and spend less than you make. If you do those three, you will move up through the classes. The people that fail to do these things are downwardly mobile.

Over the weekend in a post answering anonymous reader questions, I wrote the following:

Savings accounts are wonderful places to keep money that is very liquid (meaning you can get it if you need it) and earns a small rate of return with very little risk. Because of these factors (liquid, low risk, some return), they are great places to store emergency funds, which is a fundamental part of any personal finance strategy. An emergency fund is a buffer to prevent budgetary disaster in the event of a personal crisis.

This inspired the following question from a very faithful reader who sent me an IM less than five minutes after that article was posted:

It seems to me like it is always good to put your money in a savings account that earns 5% like HSBC Direct. Why would you do anything different?

As I mention, there are indeed a lot of advantages to savings accounts. You can get at the money at your convenience, it can make a nice return in the right account (HSBC Direct, for instance, has a 5.05% APY and some smaller banks do better than that), and there’s very little risk as the account is insured by the FDIC up to $100,000. It is without a doubt a stellar place to put your cash that you may need in the short term.

However, once your savings reaches a point that is out of the reach of your emergency fund needs (at least a few months’ worth of salary), it’s time to start looking for a place to put your money for the long term. For example, the Vanguard 500 has returned an average of 12% a year since 1976, but that return isn’t guaranteed year in and year out – some years have had a net loss, while others have had returns far above 12%. It’s still reasonably liquid in there, but you can pull out at any time (we’ll not get into the taxes on your gains here, but at most you’ll have to pay the same rate as your normal income and it may be substantially less than that). There are many real estate investments that can return spectacularly, too.

Why do this? The potential returns are too good to pass up. If the Vanguard 500 continues along at the historical rate, the money in it doubles every six years, while in a 5% savings account, your money doubles roughly every sixteen years. Let’s say you put a dollar into the savings account and a dollar into the Vanguard 500 and waited 20 years. The savings account would have $2.65 in it, but the Vanguard fund (if it continues at the historical rate) would have $9.65 in it. Multiply those by a thousand or ten thousand and you’ll see why it’s a big deal.

So why not just invest everything in the Vanguard 500 or another investment if it returns that kind of money? The reason is that it’s not insured and it’s far from a guaranteed return. There have been many years where the Vanguard 500 has lost fistfuls of money (the returns from 2000-2002 were positively nightmarish, with 20% losses) – the positive numbers are only over the long term because the good years overall outweigh the bad. On the other hand, a savings account won’t lose its value – it will just stay there and chug along quietly for you, keeping your money quite safe for you.

In other words, keep enough in the savings account so that your short term needs and emergencies can be met, then take the rest and play with it for the long term by investing it somewhere.