In this economy it is not uncommon for me to hear from clients about how the uncertainty scares them. “Will I have a job?” “How does the debt ceiling debate affect me?” “They say the recession is over, but it certainly doesn’t feel like it.” There are all quotes from my clients and every time I have given them the same advice: start an emergency savings account.
I recently started work with a couple. She is currently a stay-at-home mom and he is a member of the US Military. Once she gets a job it will most likely be with the government. This couple is one that would definitely be impacted if the government had a temporary shut down due to the inability to raise the debt ceiling in a timely manner. They expressed this concern and were already a step ahead of me when they said that they wanted to start an emergency savings.
But how much? This is actually super easy to answer. Every month you spend money on things that are wants and on things that are needs. I bet you already know the difference: Rent-need, Starbucks- want. There are some fuzzy areas: designer ice cream- want, fresh fruit- need.
This also includes bills that come due every month and cannot be deferred temporarily. These include minimum credit card payments, car insurance, renter’s or homeowner’s insurance, (any kind of insurance really) utilities, car loans, appliance loans, student loans (some of which can be deferred due to unemployment).
And then there are expenses that we couldn’t live without. For most of us not having a cell phone is not an option. But when you are in a place where you have to tap your emergency savings, it is up to you to find the cheapest plan possible. No longer can you have unlimited access to Bejeweled and your email. Now is the time to go to a minutes-only plan.
Also along that vein is your Internet. If you are using your emergency savings you need to switch to the cheapest plan or tell your Internet provider your situation. Most will temporarily switch you to an introductory rate to keep your business in hopes that in three months you can start paying the higher rate again on your current package.
So for my sweet government paid couple they need to cover rent, electricity, a car payment, car insurance, some medical insurance, groceries, Internet and cell phone.
Note that there is no mention of eating out, not even the occasional splurge. And the assumption is that they would be driving significantly less so there we added these numbers up and rounded to the nearest whole number to cover a few gallons of gas a week. No more than would be necessary to buy groceries and maybe drive to an interview or two.
Now the question is how many months of expenses you need to keep. This number can range from 3 months to a year’s worth depending upon the field you work in and the likelihood you’ll have in finding a job quickly.
For those of you in the arts and who are freelancers, 6 months minimum, 9 months is better. But for those of you in technology, 3 months is more than substantial. A year is for those whose job consistency is unreliable and who feel best having a larger cushion.
Now how to start saving. I recommended to my couple that they automatically get an amount deducted from their checking account every month when their paycheck comes in so they don’t have to worry about it. By doing this using that money doesn’t even become an option.
I personally use Ally Bank, an online bank, which has a savings account with a 1.1% return. Dismal? Yes. Better than everywhere else? Hell yes.
Other good online banks include HSBC and ING Direct.
So now how to figure out how much to save each month. First, I think 3 years is a reasonable amount of time to build up an emergency savings. Within a year is the best, but let’s be reasonable about how many people can put away that kind of money in a year. If you could, you probably already have a savings account.
My favorite tool is an online calculator found here.
It looks like this:
A quick lesson: An ordinary annuity is a regular payment that happens at the beginning of a period. Your mortgage payment is an example of that. Any loan is an annuity. If you pay at the end of a period, it is an annuity due. Whatever. Back to the fun stuff…
In the “Nominal Rate” you put in your savings account rate. For me 1.1%
In the “Periods per Year” you put in 12. You are paying this monthly, right? Yes you are. Unless you are not listening to me. If you’re not and only doing this once every 3 months, put 4. Once every 6 months, put 2.
Now “Number of Years” and “Annuity Payment” this is where your experimentation takes place. For example, I’m trying to save $7500 for my emergency savings. I wanted to get it in 3 years. So I entered 3 into “Number of Years” and then I tried a bunch of different monthly payments. I learned that $205 per month would get me to $7500 in 3 years:
Luckily for me, a CD I didn’t know existed came due and I was able to have about $6000 to start saving on top of for my emergency savings.
So do yourself a big favor. Do the calculations, play with the calculator and get going on an emergency savings.
One final note, emergency savings are great for emergencies other than unemployment. I recently tapped into it to pay for some car repair so now I’m working to build it back up to my $7500 level.
If you have any questions, feel free to post in comments or send an e-mail to email@example.com
And if you’d like your own analysis about how much savings you need, my starter packages are still on sale. You can learn more about then here.