Financial Wealth Development - Principle I
Save for a rainy day
..because I’ve looked at the forecast… and chances of rain are 100%
When you save for a rainy day, you’ll never be “broke” again! When you build the habit of having a financial reserve, you will be insulated against lack and hunger. You will also be prepared for the “surprises” in life, which come up for each and every human-being. Most importantly, you will have changed your relationship with money from something that can be problematic to a useful tool. The message you are giving to money when you save for a rainy day is “I expect you to be there when I need you.”
How much should you save and how should you do it?
If you don’t have any savings, start by targeting $100 that you never touch. If $100 seems hard, start $1 at a time.
Earn a return on your wealth: Open up a high-interest-rate savings account. Currently, Marcus by Goldman Sachs, Barclays and Capital One offer interest rates above 4.0% and do not have a minimum account balance. Get in the habit of earning a return on your wealth and do not settle for the low interest rates that many savings accounts offer.
Automate your saving: Set a certain amount to contribute to your savings account each month. This amount should be moved automatically from your checking to your savings account each month. Even if it is only $5 per month, you are starting an important habit of automating your saving.
Once you have $100 that you never touch, target a savings amount in relation to your monthly expenses.
Know your monthly expenses: Knowing your monthly expenses (some people call this your monthly “nut” or monthly “baseline expenses”) is important for several of the principles I will share. It is essential for this particular principle because the amounts I recommend you accumulate in savings are all in relation to your monthly expenses.
Individuals without a significant amount (more than $250/month) of monthly expenses: Target $1,000, then $3,000 then $5,000, then $10,000. If you do not have significant monthly expenses this means you most likely are a dependent. You may be living with your parents or other family members. $5,000 will likely be enough to cover a security deposit and first month’s rent on an apartment and leave you with some funds to begin furnishing that apartment. Realistically, fully furnishing that apartment and having some cash left over for other emergency needs will require you have about $10,000.
Individuals with no dependents should target: First 1/2x monthly expenses, then 1x monthly expenses and ultimately 3x monthly expenses. The reason we target 3x monthly expenses at a minimum is that if you were to experience an interruption of your income (e.g. a job loss), the minimum amount of time you should budget for the disruption is 3 months.
Individuals with dependents and individuals who want to be financially secure: Target 6x monthly expenses. If others are depending on you, it is important to plan conservatively for disruption. Again, 3 months would be the minimum time you should expect for a job loss. Even if you don’t have dependents, if you want to consider yourself “financially secure” you need to have at least six months expenses saved in order to weather disruption and not find yourself feeling desperate during the time of disruption.
For those of you who have never had six months saved, you will be amazed by the feeling of security that comes with knowing you can weather potential storms. Obviously, job disruption is not the only kind of storm. Unexpected expenses are also very disruptive. If you incur such expenses, you can use the savings and then rebuild the savings once you’ve gotten past the storm.
As such, six months is a really good target for anyone!
Individuals who anticipate career changes, especially those with dependents: Target 1 years expenses. A lot of people fall into this category. I’ve been in this category for quite some time. Over the last few years I’ve done property management, asset management and consulting in addition to the income I earn through real estate investing. About 2/3 of my monthly expenses have been dependably covered, while the other 1/3 has come from sources that aren’t as dependable or sustainable. As such I target 1 years savings to give myself the ultimate flexibility to experiment with income streams. If you are facing uncertainty about your income streams - even and perhaps especially if that uncertainty is self-imposed, I encourage you to give yourself the flexibility to experiment by securing 1 years worth of expenses.
Beyond 1 years expenses, most people should cap their savings and invest anything above that amount so that you can earn a higher return. In fact, once you have 3 months saved (and sometimes even earlier) you should also be investing alongside the saving strategy.
How to save:
Open a high interest rate savings account
Set an easily affordable savings amount
Set up an automatic transfer from your checking account to your savings account with the following important caveats:
Work toward establishing a $1,000 cushion in your checking account (see item #3 for why)
Pick a savings amount that is totally sustainable for you. It makes no sense to place unnecessary burdens on yourself that are not sustainable. It won’t work. You are better off picking an amount that works for you. Once you have a good habit going, you will find it easy to increase this amount.
NEVER put your checking account at risk of overdraft with your automatic savings. This means you need to say goodbye to the days of cutting it close in your checking account FOREVER! I recommend you start with a $1,000 cushion. This means you never touch the bottom $1,000 in your checking account. Unfortunately you won’t earn much money on this $1,000. Its sole purpose is to allow you to safely automate your savings (and later your investing). The power of automating these items will compensate you financially and psychologically for the $1,000 you’ve left in your checking account.
Establish your target savings amount. You may think this should be the first item. It is most important to build the habit of saving and to make it easy by automating it. Once you’ve done these things, the next most important thing is to be deliberate about what you save. So set your target and think about how to increase your savings amount to get there faster.. but be patient! There is no rush.
Of the 6 essential principles of Financial Wealth Development and the entire list of 10 principles I will share, this one may seem basic. However it’s the first one for two reasons. One, when you save for a rainy day you will never be broke and you will have irrevocably changed your relationship with money. Two, you will be prepared for the disruptions that are guaranteed to every human breathing air.
With principle 1 as a foundation, you are undoubtedly developing real and sustainable WEALTH!
wellbeingGrant
FAQ’s
What are example of “surprises,” which would indicate a “rainy day?”
A family member has an emergency needs and asks for help
You take your car in for an oil change and the mechanic tells you that you need new brakes or tires
Shouldn’t I focus on investing to get a better return vs. saving?
It’s not either-or. You can invest while building up your savings. You NEVER want to have to disrupt your investment (i .e. sell an investment because you need the money). As such, be sure to put yourself on firm financial footing by establishing a savings that truly inoculates you from financial emergencies by putting the savings in place. The habits are much more powerful than the amounts! You may feel you are saving or investing too little to make a difference but these actions compound over time when you do them in a sustainable way.
I’ll cover this more once we get into Principle 7 (“Invest with diversification to beat inflation”), but you can use the following calculator to see just how easy it is to accumulate a nest egg by investing consistently
https://www.investor.gov/financial-tools-calculators/calculators/compound-interest-calculator
The S&P has returned about 10% since its inception in 1926. Some years are good and some are bad, which is why the key to investing is giving your investment TIME to grow.
Just $25/month invested over 20 years, compounding monthly at a 10% annual return will yield a nest egg over $18,000. $100/month with the same parameters will yield almost $76,000. If you start at 20 and give yourself 40 years to compound, your $100 monthly contribution will yield $632,000 and if you do it through a Roth IRA, you won’t pay taxes on the huge profits.
Whether $25/month or $100, hopefully you can see that you don’t have to choose between saving and investing.