Thursday, March 10, 2011

Building a cushion

Returning to the topic from a couple of days ago: 

Building a cushion for emergencies isn't magic, but it does take discipline. The first requirement is that you have to get your expenses down to no more than your income. Be realistic. Don't budget $75 for your utility bill when you know it's going to be at least $150. Then you have to push your expenses down, or your income up, at least a little.

If your family income is at least moderate, this shouldn't be too difficult. Look at discretionary spending first (i.e. do you really need to pay for that cell phone package that lets you get infinite downloads when you already have ordinary internet access? How about that $4000 cruise vacation instead of spending a few days in a nice hotel for $500?) Then look at "soft" expenses such as food and utilities. And while most people seem to rule out "hard" expenses, such as mortgage/rent and car payments. I think these expenses should be evaluated too. Do you really need a 5 bedroom/3 bath house when all the kids have left home? If so, can you take in a lodger or two to put some of that extra space to use? Aim to reduce those minimum monthly expenses to 80% or less of your take home income.

If your minimum monthly expenses are $2000, your ultimate goal is $6000. Don't panic, though, you can do it in bits, and the more you have saved, the more you'll be able to save (more about that later). Assuming you have a take home income of at least $2500, you should be able to put aside $100 a month ($25 a week) without a problem. PAY your savings first, just like it was a bill, then pay your basic expenses. Then pay your basic bills. You should have about $100 a week left for emergencies and entertainment. In just over a year and a half, you'll have $2000 for the first month's expenses saved.

Now, a brief detour for those with consumer debt. Do NOT touch that $2000 except in genuine emergency (replacing the big screen tv is not an emergency, by the way). Let it accumulate interest. Begin paying off your consumer debts with that $100. There are two main approaches. One pays off the smallest debt first, the other pays off the one with the highest interest rate first. Both have advantages, but although I generally favor paying off the high interest debt first, many people find that the thrill they get from completely paying off the smallest (fastest) debt motivates them to keep going. Whichever approach, apply that extra $100 to a single debt. When it's paid off, apply the $100 plus the minimum payment you were making to the next debt. If you have multiple credit cards, get rid of all but the one or two with the best terms. And by the way, if you have a lot of consumer debt, you really should consider taking at least $100 of your spending money to apply to this.

Once you're up to at least $200 toward the consumer debt, start putting $50 a month of that money into your emergency savings again. If you had no real consumer debt, continue putting your $100 a month. In just over 3 years, you'll have 2 months of emergency funds. In 4 and a half, you'll have the three months of emergency funds.

Want to get there faster? Put 10% or even 20% of your income into savings. At 10%-$250-you'll have the first month's expenses in 8 months. At 20%-$500-you'll reach that goal in 4 months. But don't cut yourself too short unless your consumer debt is high or you're concerned you may need that money soon. Remember you'll be gaining interest as well.

Now, how does savings make it easier to save? Say you have that $2000 saved up, and you're whittling down your consumer debt, and your car breaks down, a $800 repair bill. Without savings, you'd have to put that repair on the credit card. At $25 a month, it will take about 40 months to pay it off and cost about $1000 total. That same $25 a month put back into savings replaces the money in about 32 months, and gains interest at the same time.

If your take-home income is closer to $5000 a month, as long as you don't live someplace with an unusually high cost of living (i.e. NYC, Los Angeles), you ought to be able to get your basic expenses down below $4000 a month, at least temporarily. Save at least 15% of your takehome, $750 at $5000, and in 5 months, you'll have the first month's savings.

This may sound depressingly "poor", but it's really the opposite. If you can free yourself from debt, you'll be amazed at how much extra you have in your budget. And when you have savings, you have much less stress.

For those who are already near the edge, find even $25 a month to save. And cut expenses to the bone. Cut out sodas entirely, and that could get you $40 a month or more alone. Turn off the cable. Turn off the land line for the phone and get a single pay-as-you-go cell phone that stays at home to be used only when completely necessary. Sounds too harsh? If you're REALLY so near the edge that you can't save any money, then those things are luxuries. If you've already cut genuinely cut everything you can, find ways to make even tiny amounts of additional income. Ebay things, babysit, whatever it takes to make an extra $25 a month. In a year, you'll have $300. It may not be a huge amount, but it's a start.

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