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.
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