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8/20/13

Building a Financial Safety Net, Part 1: Getting Started

Much of survivalism and a prepared lifestyle involves having ample reserves in place to weather the tough times. It's the case of the grasshopper and the ant - we are the ant, preparing for winter before it comes.

We focus on having food stored, stockpiles of ammo, spare parts and redundant gear, but far too often we ignore the financial side of things. Having a reserve of money for unexpected events and tough times is a wise, common-sense goal that virtually every financial expert recommends working towards.



How Much Do You Need?
Exactly how much value you should have stored up in your safety net is going to vary from individual to individual. The basic calculation is simple:

Months Without Income X Monthly Expenses

So if your monthly expenses were $2500 and you wanted a three month reserve, you would save up $7500.

The math is based off of having a safety net to get you through a period of unemployment and no income, but that nest egg can also of course be used for other financial emergencies.

What falls under monthly expenses?

Anything that you must pay monthly; non-discretionary income that you can't cut back on if you needed to. Mortgage/rent payments, car payments, utilities, insurance, gasoline, etc. Not the $100 you spend at restaurants every month or the $75 you spend on cable. I would recommend including your monthly food budget in those monthly expenses as well--we'll get more into detail on that in the future. List the important stuff up and total it up--there's your monthly expenses.

Starting off with one month worth of expenses is a good first goal. Then extending that out to three, and then onward beyond that, ultimately working towards six months to one year worth of expenses saved up. For a bit of perspective, the national average time spent unemployed sits at around 35 weeks...almost nine months. Yikes.

The stability of your income should play a role in your final goal--if your income or employment are inconsistent, then the longer side of that safety net would be prudent.

As with all good goal setting, you should set a time frame and deadline for accomplishing your goal.

You'll need to be patient, too, unless you are blessed with an income that far exceeds your monthly expenses. 10% to 20% of your income per month into savings is generally considered a fairly healthy savings rate - and at that rate, it would take roughly 5 to 10 months to build up one month worth of reserve.

If you're starting from scratch, saving up and setting aside several thousands of dollars is no small task, so give yourself a realistic amount of time to work with.

To figure out how much you'll need to save on a monthly basis, divide your goal by the number of months you've allotted.

Taking the $7500 reserve from earlier and a 18 month deadline, that would look like:

$7500 / 18 = $416 per month

And, you can of course break it down even further. If you were paid on a bi-weekly basis, you'd want to save $416/2 = $208 per paycheck.

Building Your Reserve
We often hear about "living within your means." That isn't just living paycheck to paycheck and having no debt. It means having enough leftover at the end of the month to sock some cash away for tomorrow--retirement, education, tough times and so on.

If that doesn't describe you, you're going to have a very difficult time saving up even one month's worth of emergency funds. If you don't have the room in your budget to save much, then you've got three options: decrease your costs, increase your income or both. Doing both will help you get traction and make progress even faster.

Sending windfalls--bonuses, unexpected checks, prizes and gifts--right to the rainy day fund is a good practice to follow as well.

Following the math above will help you figure out how much you need to free up and dedicate to the cause on a monthly basis.

Personally, I would be very aggressive at building the one to three month reserve, and then allow the more extended reserves to build more slowly while paying attention to other financial priorities. You'll likely want/need to save for other things, pay off debt early and invest. Dedicating all of your spare money for the next 5 to 7 years into building an emergency fund is probably not practical.

Using the example above, after reaching the three month/$7500 cushion, the individual in question may want to scale back from that $416/month to $213/month and then plow the other $213 into building equity in his home or something similar.

Reality Check
Now I know some of you are saying "What? When [insert your apocalypse of choice here] money will be worthless!"

To which I respond: which is more likely to happen tomorrow: the end of days or the loss of your job?

I would argue that having a good financial reserve is one of your most important preps, and the one most likely to get used. It's almost guaranteed that you will need that money at some point in the future, near or far. It's a very big priority to work towards and an important part of being an independent, functional adult, let alone someone who prides themselves on being prepared for tough times.

Now, being prudent, aware, risk-averse folks who practice diversification, we are going to keep our reserve in a variety of forms, not just throw it all in a savings account. We'll talk more about that in the next installment of this series.

So, your takeaways:
  • Reflect on what kind of financial safety net you have in place currently
  • Do the math - figure out your monthly expenses
  • Set a goal for adding to your safety net--how many months worth of cushion you want to work towards and how long it's going to take
  • Figure out how much you'll need to save every month to meet that goal

6 comments :

  1. Now I know some of you are saying "What? When [insert your apocalypse of choice here] money will be worthless!"

    To which I respond: which is more likely to happen tomorrow: the end of days or the loss of your job?

    Agreed! Prep from the most likely to happen to the least likely. Loosing your job, natural disaster, then the nukes and EMPs, and lastly the Zombies :) (just kidding about the zombies).

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  2. I cannot imagine holding back a years worth of money in cash form, and would never advise anyone do that. A financial fallout of some degree is absolutely imminent. I can't wait to see your next installment. Diversification is key, and personally I would lean heavily to the tangible/intrinsic side of investment, given the current financial climate. Anyone who can't see the writing on the wall is kidding themselves. Unfortunately, its a WHEN not an IF.

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  3. Last week, I began the 'Save EVERY $5 BILL YOU RECEIVE' jar idea posted several weeks back and am surprised how quickly its building. If you aren't aware of it, the premise is simple - Every $5 you find or get back in change, put it away and forget about it. Its just that simple. Small enough to where you don't miss it, yet enough to build momentum.

    This obviously only works if you deal in cash. Paying with credit - debit cards, checks, money orders don't generate cash back.

    Great topic - thanks for starting it.

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  4. Saving is absolutely essential. Those who are concerned about the stability of our currency could do 1 month's full expenses in cash and the balance in PM's though they have stability issues also.

    Folks who don't save end up needing to convert tangibles into cash too fast to get most of the value. That's how lots of guns get sold for .6-.75 of their value.

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  5. I cannot think of one financial crisis in history where money became worthless immediately. Yes, there have been times where money became worthless overtime or inflation so crushing that paper money was only worth burning to keep warm. However, there has never been a case where you wake up one morning in a crisis of any kind and paper money was worthless. Paper money will be of value early in any crisis where people are betting, hoping, praying that everything will get back to normal and will accept paper money. In fact, in the early hours and days of a crisis, money will likely be the only form of payment accepted. Credit cards and checks will be worthless, bartering will not be fully acceptable on a large scale yet, most certainly not at corporate owned businesses, and if you want anything it is going to have to be in cash. Cash is king and will continue to be in the early phases of any crisis. That said, a year’s worth is a lot of cash on hand and I would feel more comfortable with a more diversified WTF Fund.

    -DB

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  6. It is far more important to live below your means and stick to a reasonable budget. By staying below your means and sticking to a budget you allow yourself the freedom to overcome short term obstacles, and plan for the future in whatever form of savings you prefer (cash, shiny, ballistic, or edible).

    Personally my partner and I choose to have a few months of cash on hand and live below our means to pay off student loan dept at an accelerated pace.

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