Why 3 Savings Accounts Are Better Than 1

Some of us hoard cash while paying 18% interest on a credit card balance. Others blow through a tax refund as if it were free money when it's actually a return of our own hard-earned dollars.

This brain quirk has a name: mental accounting. We treat money differently depending on where it comes from and how we intend to spend it, often to our own detriment.

We can, however, leverage this illogical behavior to help us save more.

A big pot of savings may inspire less diligence than multiple accounts with specific purposes. With multiple accounts, savings for long-term goals can grow, even as those for short-term needs are periodically raided.

Multiple savings accounts can get expensive at traditional banks that have minimum balance requirements and account fees. Many online banks, however, allow customers to set up dozens of accounts for free with no minimum balances. Most people need at least three, with regular (preferably automatic) transfers from their checking accounts into each:

• An emergency fund for job loss and other major financial setbacks

• A “needs” account to cover necessary expenses that aren’t monthly (such as property taxes or annual insurance premiums) or that are inevitable but often unpredictable (such as car repairs or medical deductibles)

• A “wants” account to pay for the fun stuff, such as vacations, holiday spending or a down payment on a new car

Multiple savings accounts are useful for budgeting in much the same way as the envelope system, where people divide cash into envelopes to cover expenses such as rent, food and entertainment.

The savings accounts, like the envelopes, tell you if you have enough to cover that specific goal, but also allow you to shift money around when required, said Rachel Schneider, a senior vice president for the nonprofit Center for Financial Services Innovation and co-author of the book “The Financial Diaries: How American Families Cope in a World of Uncertainty.”

“Knowing that you have that escape valve allows you to put more money aside in those accounts,” Schneider said.

Banks and apps that make it easier

There’s some evidence that setting goals helps motivate people to save more, which has led to apps such as Tip Yourself, BoostUp and Qapital. Qapital, for example, allows people to set goals and then create rules for funding them, such as rounding up each purchase to the nearest dollar and sweeping the change toward the goal, or transferring a certain amount into savings if they buy something at Starbucks or hit 10,000 steps on their FitBit fitness tracker.

"Setting goals helps our users stay focused and motivated. That's why we encourage users not to label their goal 'vacation' but to name the place they wish to go, attach a photo and share it with a friend,” says Qapital founder and CEO George Friedman. “Their aspirations become more actionable when they are visualized and said aloud.”

» MORE: Easy savings apps

Getting more specific also can help you track multiple goals without wondering whether you’ll have enough money to cover your property taxes in six months if you need to pay for a car repair now.

I typically have somewhere between 10 and 12 savings accounts labeled for different goals. To cover a $1,705 annual life insurance premium, for example, I set up an automatic transfer so that $143 a month goes from our checking account at our brick-and-mortar bank into the “life insurance” account at the online bank. Repairs and maintenance for our elderly RV are less predictable, but we’ve averaged about $2,400 a year, so I put $200 a month into that fund.

Some banks and credit unions allow multiple savings accounts, but typically you’ll need to keep your balance above certain limits to avoid fees. Many online banks, by contrast, allow you to set up dozens of accounts without charge and usually offer higher interest rates to boot. Capital One 360 and Barclays Online, for example, allow users to create up to 25 savings accounts (called subaccounts) with nicknames indicating the goals, while Ally and Discover don’t limit the number.

» MORE: Best high-yield online savings accounts

Capital One declined to say how many savers take advantage of this function, but Ally says 11.7% of its savings customers had multiple savings accounts as of March 31, averaging 2.9 accounts each. Some of the most common labels include “Emergency” “Rainy day,” “Vacation,” “Travel,” “Car,” “House,” “Xmas” and “Wedding.”

Multiple accounts may not be necessary if you’re a logical type who either doesn’t need incentives to save or is really good at tracking goals on a spreadsheet. The rest of us, though, often find that saving finally makes sense when we know what money goes where.