Tuesday, March 8, 2011


No, this isn't about making new cushions for your couch. This is about a "cushion" in your budget. I think everyone should know how much they need, at minimum, to get through a month (rent or mortgage, minimum payments on CC, food and gas) and have at least 3 months worth of expenses saved in some accessible form. Why? This is your "cushion," what you "land" on if you suddenly lose your job or have a major unexpected expense. Even better, have 3 months in a safe, relatively liquid form (i.e. some sort of savings account) and another 3 to 9 months in something safe you can tap into in an emergency (i.e. CDs).

I hear lots of arguments against this. One is the bizarre idea that savings takes money out of circulation. Bull. Banks do not take in your money and store it in a vault somewhere. They reloan that money at a higher interest rate to businesses and new home and car buyers. If anything, you're stimulating the economy by making this credit available. 

OK, so you didn't spend it on consumer goods, so you didn't stimulate the economy that way. What a hypocritical argument that is, making spending money with a corporation into a patriotic act! Does that argument work both ways; do corporations line up to show their patriotism and loyalty? Ask yourself how many of their jobs have left the country, and how much tax do they actually pay? How many executives collect obscene bonuses when their companies lost money or laid off ordinary employees to "cut costs"? If you spend $500 on one of their gadgets this month, do they line up to help you out next month if your car breaks down?  Then decide if patriotism comes into.

Another argument is inflation. Maybe. However, I've looked at how they calculate inflation, and it is not a measure of basic costs of living. In a lot of ways, prices are a crap shoot. You buy 50 lbs of rice this month for $.45/lb, thinking you have a great deal. Then two months from now, a bumper harvest comes in or some corporation turns out to have hoarded rice to push up the price, now dumps it on the market, and the price drops to $.30/lb.

A lot of people tell me, oh, I'll just put a major expense on my credit card. Wow. You know, credit card companies now give you clear numbers on your statement showing what you pay over the life of the loan. Pay attention to it. The loan you get through a credit card is EXPENSIVE. I have one credit card, and that's all I want. I pay off the balance every single month, and in almost 11 years, I've only carried a balance once, in special circumstances, for about 4 months.

Why have some savings? Well, you go to work tomorrow and discover your employer closed down over the weekend. Time to apply for unemployment. In Texas, if you were making about $2500 a month on salary before taxes, you'll get a whopping $306 per week in benefits, or about $1300 a month (I multiply weekly by 4.3 since there's an extra week about every three months). Your after tax take home pay was about $2200 and say your basic expenses are $1900; the difference between unemployment and your expenses is $600. If you're well paid, keep in mind that the maximum weekly benefit in Texas appears to be $415. If you're an engineer making $80,000 a year, your income is going to drop dramatically to about 1/4 of what you were making.

I don't know what the current average job search is, but let's say 3 months. At $2500 salary, person A is going to need $1800 to bridge that 3 month gap (this assumes that he gets paid wages owed by the ex-employer).  If he already had a balance of $1800 on the CC (fairly average), he's now up to $3600. His new job only pays $2100 a month for an after tax income of about $1900, and he has to buy about $250 in new clothes for the job, all going on the CC. With the interest on the new credit card balance and a slightly longer commute, his expenses are now about $1950 a month. Ooops. Now he's making $50 less a month than he spends, with a credit card balance that's close to $4000 already.

This is where that cushion comes in. Person B had one and a half month's expenses saved and with no credit card balance, his expenses would have been about $20 less a month, $1880, and that $2820 he had saved would have covered the $580 difference between his expenses and unemployment for three months ($1740 from $2820 is $1080). The $250 for new clothes would leave him with $830 in savings. His expenses on the new job would still be about $20 less a month than the new take home pay. Whew. If he cuts expenses by about $30, in a bit over 3 years, he'll have rebuilt that cushion.

To me, the second person also has a better chance of finding a job faster and a better paid job at that. Why? Less stress. Person A is going to be frantically trying to figure out how to make ends meet, spending time on that worry instead of concentrating on the job search, and is more likely to take a poorer paying job just to have ANY income. Person B may be stressed, but he knows he has that cushion, and AFTER that, the credit card which has no balance. He's more focused on his job search and spends more time on it. If he'd had 3 months of expenses saved, there would be even less pressure. With 6 - 12 months of savings, this job loss has the potential to turn into an opportunity to start his own business or go into something new.

This post is already very long, so I'll try to cover how to build a cushion later this week.

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