Using Savings as Self-Insurance

When you buy a new car, a new computer or even a new cell phone, you'll be offered an extended warranty. Here's a hot tip: don't buy it.

Paying for a warranty is betting that the product you just bought will fail within a certain time frame. And that you'll be able to find the warranty paperwork when you need it.

It's almost always a sucker's bet. Think about it: if warranties routinely paid out, how would the warranty companies stay in business? They need to be able to pay salaries to employees, run their offices, advertise their services, and pay out claims. Their revenue comes from selling warranties. It only stands to reason that, more often than not, they don't pay out for the products that they insure.

How to Build Savings: Don't Buy Warranties on Small Purchases

Instead of taking that bet, put the money you would have spent on the warranty into a high interest savings account. Earmark it for repairs or replacement of your car, computer, camera, or what-have-you, and add a little bit to the account on a regular basis until you have the full replacement cost set aside in case of a product breakdown.

Of course, warranties often cost only a small fraction of the replacement cost of an item. That's why we buy them. When I spent $12,000 on a used car last fall, I bought a warranty for it because I didn't have $12,000 I could park in a savings account for the next five years.

As it happens, the $1,000 I did pay for that warranty was redeemed when a covered repair came up less than a month after the manufacturer's warranty on my car expired. So I won my foolish bet, just like people sometimes leave Las Vegas with more money than they came in with.

I made that bet because I was still paying off other debts and did not have a lot of cash savings. But if you're financially secure, with solid emergency funds in your savings account, your best bet is to bet on yourself--by directing some of your savings into a targeted sub-account to pay for repairs or replacement on the expensive goods you own.

Let Savings Account Rates Work for You, Not the Warranty Company

If you buy a new laptop or camera, stash the replacement cost in an account and let it earn interest. You'll want to replace that item eventually, and in the meantime the fund can cover repairs that crop up.

Even if you don't have the savings to insure the entire replacement cost right off the bat, you're probably better off starting with a nest egg--the money you would have spent on that warranty--and then adding a bit to it every month. If you can't afford to do this, you probably shouldn't be spending money on an expensive product, even one you think you "need" such as a car. If you can afford the goods, you can also budget in some money to dedicate to repair or replacement costs. Stick with that budget. You'll have the money there when you need it.

Best of all, you can always decide to spend that money on other things. When you buy a $70 warranty on a piece of electronic equipment, you've just committed $70 to repairs for that item. Maybe you'll wind up getting a $200 repair covered by the warranty, but more likely your new gadget won't need any repairs at all during the covered time.

If you'd plunked the $70 into your savings account, you'd now have that $70 plus interest to do whatever you want with, instead of some dusty warranty paperwork.

There are some big-ticket items that most of us can't self-insure, because we simply don't have the means. Our homes, our health, and our lives are all examples of things we'd need hundreds of thousands of dollars in insurance on. You don't want to keep all that money cooling in a savings account just in case, and unless you're quite wealthy, you probably can't.

For consumer goods, though, self-insurance is a safer bet. You'll get the peace of mind that comes with a warranty, plus the flexibility that comes from having more money in the bank.

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