A recent article on CNNMoney.com caught my eye – it’s titled “Many don’t have $2,000 for a rainy day.” Since one of my cardinal rules for retirement planning is that you should have 6 months of spending in the bank (or easily accessible, within 3 days), I read this article with interest.
The CNNMoney.com article references a recent National Bureau of Economic Research study which asked participants if they could come up with $2,000 for any surprise expense, such as a home repair, hospital bill, short-term job loss, or legal expense. Frighteningly, only 25% said that they were certain they could find the $2,000 without a struggle. What does that say about the other 75%? The others said they would access their savings accounts, borrow from neighbors or family, put these charges on their credit cards, or use other borrowing methods such as home equity loan.
Let’s step back here and think about this question. Assuming that you would like to retire someday (I define “retirement” as doing what you wish with your time, vs. being required to work to pay current and expected future expenses), you’ll have to either be very lucky and win the lottery, or you’ll have to save from your current income. Unfortunately, life sometimes throws us a curve ball in the form of an unexpected expense or perhaps a loss of a job or other income source, and we must cope for a short period of time. If your strategy for “coping” is to borrow money from your friends or use your credit card instead of accessing a short-term savings account, then you’ll never dig out of the debt trap and you’ll be forced to earn an income for the rest of your life!
What if you had a goal to put six months of what you spend each month in a bank account and labeled it “rainy day account”? This isn’t easy; if you typically spend what you earn each month it might take some changes to your spending habits to save 5% or 10% each month. Remember, we’re not talking about what you earn pre-tax or what you have in your paycheck after-tax for this calculation – we’re talking about the amount you actually spend each month. So, if you could save 10% of your spending each month for a year, you’ll have 1.2 months saved in just one year. Using this plan, you’ll have 6 months of spending in that account within 5 years.
5 years sounds like a long time, just to have a rainy day fund. What I’ve found over the years is that those who start on this plan quickly find ways to save without really impacting their lifestyle, and they also find ways to make more income, thus compressing the time required to get to the goal much faster. What’s more, if you have 6 months of savings in the bank, not only will life’s little (or big) emergencies not derail your entire financial future, but you’ll have the mindset of saving, which will allow you to direct your income to productive investments, vs. just spending today.
To be sure, this transition from “earn now, spend now” isn’t easy. But when you compare it to potentially having to work for your entire life it isn’t as painful.
What can you do to get started with your “rainy day fund” today?