How to Use Bucket Budgeting to Overhaul Your Finances

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You know the drill: You're supposed to save up at least three to six months' worth of expenses in an emergency fund. That way, you're covered in case of a job loss, an expensive car repair, or another "life happens" moment. You've set up an automatic transfer into your savings account to make sure you don't have to rely on your own inconsistent memory to fill it up. You should be all set.

So why is it that you never seem to have more than a couple hundred dollars in your savings account, despite making all the right moves?

It's likely that your savings account doesn't have a specific purpose, which makes it much easier to make withdrawals for nonessentials. That's where bucket budgeting (also known as targeted savings) comes in.

Here's what you need to know about bucket budgeting and how it can improve your finances.

What is bucket budgeting?

Bucket budgeting is similar to the old-fashioned envelope budgeting system, where you would set aside cash in different envelopes labeled with their purpose. For instance, under the envelope system, if you budget $400 per month for groceries, you would put $400 cash in an envelope marked "groceries" each month, and only spend that particular money when you went shopping at the supermarket. With bucket budgeting, however, instead of setting aside cash in envelopes for regular spending, you set up targeted savings accounts for various savings goals.

For instance, let's say you've had to take money from your savings account several times over the last year to help pay for a car repair, a leaking water main in your house, summer camp for your kids, and your anniversary trip with your spouse.

Even though each of these purchases may be perfectly valid reasons to dip into savings, it's tough to know if you're making good choices with your money if it's all in one place. That's why bucket budgeting would have you create five sub-accounts for your savings, each with a different savings goal:

• Emergency: $1,000

• Car repairs: $500

• Home repairs: $500

• Kids' camp fees: $650

• Anniversary trip: $350

With this system, you have a better sense of how much is available to spend. In addition, it's much easier to scale down your anniversary trip expectations from "a week in Mexico" to "a weekend at a local bed-and-breakfast" when you realize what you'd be taking the extra money from.

Bucket budgeting and motivation

The other aspect of bucket budgeting that can really kick your finances into high gear is the motivational aspect of it. We are much more likely to feel excited about saving money if we have a specific goal in mind.

This increased savings motivation stems from our mental accounting, which is our tendency to value money differently depending on how it is physically and mentally labeled. You might feel no compunction about "borrowing" $500 from your general savings account for that getaway with your spouse, but taking that money from your kids' camp fund would hurt. (See also: What Happens When We're Not Logical With Money)

In addition, it's a lot more fun to see a savings account with a specific purpose grow over time than it is to see a general fund get bigger. Seeing money transferred from your checking account to your savings account can be dull and painful, but seeing money go from your checking account to the account where you're saving for a dream vacation or a new car can be downright enjoyable.

How to create your buckets

There are any number of goals you could be setting money aside for, so how do you determine which goals should get their own bucket? In general, there are four types of bucket categories you will want to create sub-accounts for: emergency expenses, irregular expenses, big-ticket items, and dreams. (See also: Reach Your Money Goals Faster With a Simple Naming Trick)

Emergency expenses

These are the urgent expenses that you have no way of predicting before they crop up. These include things like car repairs, home repairs, or medical needs. These needs can each have their own buckets, in addition to a separate emergency fund that you keep at least $1,000 in.

Why have separate funds for these emergency expenses when you could have just one emergency fund? Having separate buckets for the various emergencies you might encounter can help you weather those times when everything seems to break all at once. That way, if you need to take care of a car repair, fix a broken window, and get an emergency root canal all in the same month, you will still have some emergency money to fall back on just in case something else goes wrong. (See also: 7 Easy Ways to Build an Emergency Fund From $0)

Irregular expenses

Irregular expenses are the ones that are predictable, but don't come as part of your regular monthly budgeting. They include annual, biannual, or quarterly bills, membership dues, and taxes. Any expenses that you kick yourself for having forgotten are excellent candidates for bucket budgeting.

For instance, how many times have you been surprised by an annual bill? Without bucket budgeting, it's easy for the annual car insurance bill to slip your mind until it's staring you in the face and you're scrambling to pay it.

How much to put in emergency and irregular buckets

To figure out how much to put in each of your emergency buckets and your irregular expense buckets, go back over your expenses for the past few years and determine about how much you spend per year on each type. Divide each expense total by 12, and set up automatic monthly transfers to the specific accounts. That way, when an emergency occurs and when an irregular expense comes due, you'll have money already set aside to deal with it.

Big-ticket items

Your laptop, your phone, and your car are all items you use everyday that have a limited life span. Bucket budgeting can help you be prepared to replace any of these items should something happen to them. Setting aside a little money each month is a lot easier than trying to find hundreds or thousands of dollars all at once.

In terms of saving for a car replacement, consider transferring the equivalent of your car payment to your "new car" sub-account once you've paid off your current car. For your laptop and phone, divide the cost of a replacement model by 24 and put that amount in each sub-account per month, so that you'll have enough for a replacement within two years — and hopefully you won't even need it.

Dreams

Bucket budgeting is also a great tool for helping you to realize your dreams. Whether you want to buy a house, travel, or learn how to brew beer, you'll be in a much better position to follow those dreams if you're saving for them. Having separate, targeted accounts for each one of your future goals means that you are always working toward those goals. It's a lot tougher to forget to save for a goal if you have a specific account named for it — and it's a lot harder to borrow money from your dreams than it is to borrow from an unnamed savings account.

Where to put your buckets

Both online and traditional banks have gotten into the sub-account savings game. You can start with your regular bank, although it can be a good idea to have your buckets in a different bank. Not only does that lessen the temptation to dip into your savings accounts unnecessarily, but you can also take the time to shop around for the best rates, since your money might as well be working for you.

Bucket budgeting for the win

Putting a name to each one of your savings goals not only helps you save more and spend less, but it can also help you to be more prepared for potential financial problems — and feel more relaxed when they do occur.

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