25 June 2012

More about Emergency Savings

We've all been through some tough times lately, or know well someone who has. Emergency savings seem to be more of a luxury than ever, but in reality, they are more of a necessity than ever.

We talked about getting your first emergency savings account started last year: Your Karma $1,000

Recap: 1) Saving $1,000 makes you less vulnerable to small attacks on your income. 2) More savings leads to mo' bettah Karma 3) Make saving the money as transparent as possible...if you never see it in your checking account you won't miss it as much.

According to this article published by CNNMoney, 28% of American households have no emergency savings at all. Zilch, bupkis, nada, niente. More Emergency Savings Needed!

Nobody is telling us that saving money is easy. It's not. It can be made less painless, though. The easiest way to do this is to have a portion of your paycheck directly deposited into a savings account. Talk to your HR department and have them set this up for you. It's their job, you are not asking for any favors.

Another helpful exercise is to ask yourself what would happen if you had an emergency expense happen right now. Let's not even get so severe as to talk about a job loss. What would happen if you had to replace a major home appliance right now? Try to find a refrigerator that meets your aesthetic and functional requirements for less than $1,200. If you put that on a credit card with a 24% interest rate and paid it off over a year, that's about $115 extra out of your budget per month.

What would happen if you had to replace a car? Insurance helps, but most reasonably priced policies only cover the replacement value of your car. And after the trauma of an accident, don't you deserve a little shiny and some more safety features?

OK, we do need to address job loss. This is America and we're in a recession. Most planners recommend at least three months worth of living expenses as an emergency savings fund. It may help to keep in mind that "living expenses" and "salary replacement" are two separate things. If you are not earning a salary, you're not paying taxes or making retirement fund deposits, which should make you feel a little better, no? However, if you are not earning a salary, then you are not having things like health insurance paid for, so that needs to be taken into account. When calculating living expenses, keep the following in mind:

  • Rent or house payment
  • Debt obligations such as student loan and car loan payments
  • Credit card minimum payments
  • Utilities and transportation costs
  • Insurance payments - home/renters, auto, health
  • Groceries and eating out. You don't have to totally hibernate while you're unemployed.
How many months' of expenses do you really need? As with all financial planning questions, the answer is "It Depends." Are you planning for just one person or for a multi-income household? Do you have other sources of income that you can tap into during hard times? Is your pay dependent on commissions or other irregular cash flows? Have there been layoffs in your industry or at your company? How long do you think it will take you to find another job? Take all of these factors into account, but don't go overboard. You don't want to neglect saving for retirement so that you can have a year's worth of living expenses in a low-interest rate savings account. Keep a balanced perspective here. 

It's a scary topic for scary times. Although it isn't much fun to anticipate hard times, it is better to talk about building an emergency fund now, before you need it, rather than to wait until the need is imminent.