The next step on CovingtonAlsina’s Hierarchy of Financial Priorities after cash flow is emergency savings.
Prior to the 2008-2009 financial crisis, we typically recommended having three months of living expenses in a savings account. By savings, we mean a savings account at the bank, money market, or high-yield savings account. After the financial crisis, when many people had trouble finding a new job, or took substantial pay cuts, we’ve increased that recommendation to six months of living expenses. To calculate that, add your mortgage or rent, any required debt payments, insurance, food, and other necessities.
Before you panic, know that the average American can’t meet an unexpected $400 expense. And six months of expenses is a big number. It’s not something most people will reach easily. It’s also not a linear process. You build savings, then a car breaks down. You rebuild, then a pet gets sick. That’s normal.
What’s also normal is that it is often hard to save. Our subconscious works against us, in that if we can see the money, it thinks that money is available, even if we consciously know it is not. It makes it harder to control spending.
If you’re ready to start building savings, either hide one of your current accounts on your banking app, so that you don’t see it when you check your balances or open an account with a different bank. Then, ask your company to split your paycheck. Start small, with $5 or $10 going to savings each paycheck.
What you want to avoid is jumping in with both feet and trying to save a few hundred dollars per paycheck. When you have to dip into savings, it makes you feel as though you have failed, even though you haven’t failed – you just put too much in savings to start with!
Once you go a few months with the smaller amount, increase it. You can also increase it any time you receive a raise. If you get a bonus, gift, or other windfall – split it. Enjoy part of it and put part into savings. Over time, your savings will grow. Once you have 3 months of expenses saved, you can consider investing the next part of your savings, to offer the potential for more growth.
The six-month recommendation will also vary based on your employment. If you and your spouse are both government employees, three months of expenses may be enough. If you are a commissioned salesperson, or self-employed, you may want to have more savings between your business accounts and your personal savings.
You can find great resources, calculators, and register for our educational events on our website at www.covingtonalsina.com. If you have questions, email us at info@covingtonalsina.com. We’ll continue in the next column with an overview of asset protection.
by Ann C. Alsina, CFP®, CPWA®, CovingtonAlsina
CovingtonAlsina is a registered investment adviser. Information presented is for educational purposes only and does not intend to make an offer or solicitation for the sale or purchase of any specific securities, investments, or investment strategies. Investments involve risk and, unless otherwise stated, are not guaranteed. Be sure to first consult with a qualified financial adviser and/or tax professional before implementing any strategy discussed herein. Past performance is not indicative of future performance.
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