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How To Get Your Savings Back on Track
Advice from David Bach
Follow these easy steps from personal finance guru David Bach and re-build your rainy-day savings fund.
The biggest obstacle to setting up an emergency fund isn’t convincing yourself that you should but convincing yourself that you can. I can’t tell you how many students and clients of mine over the years have said to me something like this: “Come on, David, let’s get real. I can barely make ends meet as it is. How can you possibly expect me to scrape together several thousand dollars and just leave it sitting in a bank account somewhere?” My answer is that it’s not as impossible as you think. To begin with, there’s the Latte Factor: As I demonstrated in Step 2, you could easily be wasting 5 to 10 dollars a day—maybe a lot more—on unnecessary expenditures. This money would do you a lot more good in a rainy-day fund. Indeed, your first priority with any money you save by fixing your Latte Factor should be funding an emergency account.
Now, by themselves your Latte Factor savings may not be enough to build a big financial cushion very quickly. Especially if you’re starting from zero, you’re going to have to dig a bit deeper in order to get an emergency account fully funded anytime soon. This could mean temporarily giving up something that may be important to you but isn’t actually essential—like premium cable or eating out or taking cabs instead of the bus. It may not be pleasant going without something you’re used to, but, hey, this is a priority. And, anyway, the sacrifice won’t go on forever. As soon as the balance in your rainy-day fund is where you need it to be, you can go back to watching HBO.
Again, I know what the objections to this approach are going to be. “But, David,” people say to me, “even if I could reduce my spending on paper, I just don’t have the willpower to actually do this in real life, day in and day out. It sounds like going on a diet—and we all know how those end up.” My answer to this is that there is a way to put aside money for your rainy-day account that doesn’t involve willpower or discipline or stick-to-it-iveness.
What you do is make it automatic—that is, you arrange to have a portion of your pay automatically deducted from your paycheck and deposited in an account you’ve set up just for this purpose. (You could put your rainy-day money in the same account you use to pay your bills, but I don’t think that’s a good idea. When you keep your spending money and your emergency money in the same place, it’s too easy to dip into the rainy-day fund for monthly expenses—and before you know it, your emergency fund will be gone.)
The great thing about automating your rainy day fund is that once you’ve set up your automatic saving system, you no longer have to think about it. And if you don’t have to think about it, there’s no chance you’ll forget to do it—or, worse, change your mind and deliberately not do it.
The Four Rules of Emergency Money
So how do you go about protecting yourself with a cushion of money? There are four basic rules.
1. Set yourself a goal. I’ve always said that every family should have a cash cushion of at least three months’ worth of expenses. In other words, estimate how much you spend each month on essentials (mortgage or rent, utilities, food, health insurance, etc.), multiply it by three, and that’s your minimum goal for emergency savings. If you typically spend $3,000 a month, you want to have at least $9,000 put away in a reserve account not to be touched unless there’s an emergency. Should you try to save more? Absolutely. How much more depends on what you feel you’ll need to be able to “sleep well at night.” I know people who keep two years’ worth of expenses in a special account. Anything more than that is probably excessive, but better too much than too little.
2. Make it automatic. In Step 3 I said you have to make your emergency fund automatic. That means every single time your paycheck is deposited, your checking account is set up to automatically sweep money into a separate savings account you’ve set up for your rainy-day fund. I suggest you start by moving 5% of each paycheck to your emergency account until you reach the goal you set for yourself above.
3. Put it in the right place. Once you’ve made the commitment to funding a rainy-day account, the next decision you have to make is where to park it. I used to emphasize the importance of finding a place that would give you a reasonable return on your money. But these days, with interest rates at rock-bottom levels and the stability of many financial institutions still in question, I worry more about security. Of course, interest rates won’t stay in the basement forever. But until they recover, which may not be for a long time, I’d focus less on the kind of return you’re getting and more on making sure your emergency money is safe and accessible.
4. Leave it alone. The reason most people don’t have any emergency money in the bank is that they have what they think is an emergency every month. What’s a real emergency? It’s not just having to buy a new dress for that special party. Or finding an amazing set of wheels for your car at a once-in-a-lifetime price. Or deciding you’ve got to get a new dishwasher because the old one is making noise. A real emergency is something that threatens your survival, not just your desire to be comfortable. So unless your family is about to go hungry or be thrown out into the street, you shouldn’t be dipping into your emergency fund.
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Copyright © 2009 by David Bach From the book START OVER, FINISH RICH published by Broadway Books, an imprint of the Crown Publishing Group, a division of Random House, Inc. Reprinted with permission. |
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