Are you doing well right now? Making money hand-over-fist? Living large? Think the good times are going to last forever?
Maybe they will. But then, maybe not. The foreclosure lists are full of people who thought the money would never stop coming.
The most important thing you can do to get through financial hard times is to save up a reserve of cash when times are good. It might mean missing a vacation or waiting to buy that new home theater system, but when you’re laid off and wondering how you’re going to make the next mortgage payment, you’ll be damn glad to have a few thousand in the bank. That reserve buys you time to get your income flowing again, without losing your house or credit rating, or accumulating debt that will drag on you for months or years to come.
The experts say that you should have enough cash on hand to cover six month’s worth of expenses. That’s a lot of money; $30-40,000 for many middle class families. I think that may be excessive (though if you have the resources, and you want to do that, by all means, go ahead) but some sort of reserve is invaluable. I cannot emphasize that strongly enough: It is absolutely imperative for your financial health and freedom that you maintain a cash reserve.
If you’re making money now and don’t have any ready savings (I’m assuming that you have some retirement savings, something in your company’s 401k at a minimum, but that’s not something you can access in an emergency and you don’t want to anyway.) start accumulating some, before your luck runs out. Don’t aim at tens of thousands of dollars right away. That goal will seem unattainable and you’ll be going cold turkey on some other spending you’re used to. Start small. Figure up how much you spend on groceries in a month and make that number your savings goal. (Use a savings account; you want to mentally separate this money from the contents of your checking account.) If your finances are currently in good shape you should be able to do that in a month or two. Now aim for having one mortgage payment in the bank. And so on.
Depending on how much disposable income you have (income after basic expenses), it may take anywhere from a few months to a year or two, but eventually you’ll have enough cash in the bank to live on for a month without bringing in a dime of outside income. Congratulations. You’ve bought yourself a huge chunk of financial freedom and peace of mind. That reserve won’t just save your butt if you’re axed from work. That’s what will pay off your credit card after you had to charge those home repairs. Or car repairs. Or that trip to the emergency room. What it is, in other words, is a buffer between you and debt. It’s a cash airbag that will hopefully keep you from being hurt by a shock to your finances. It is one of your most precious assets and should be guarded accordingly.
One thing that you will quickly notice about your growing savings account is that your bank doesn’t think much of it. The first time you look at your statement and realize that the $5,000 you have in your money market account has netted you 83 CENTS in interest, you will be quite justified in saying, “What the fuck is up with that?”
Now that you’ve got a satisfying reserve saved up, it’s time to vary the theme a little. The interest paid by most banks on savings accounts right now is negligible. You might be tempted to just keep the money in your checking account, for simplicity, but don’t do it. The separation you get by keeping your reserve in its own account is worth much more than the minor hassle of tracking two accounts. If you just keep it in checking what you’re going to do is spend it and that is what, in technical terms, we call bad.
So what you want to do is keep the savings/money market account, but only keep a portion of your cash reserve there. A thousand or two, maybe; just enough to smooth out the bumps in cash flow and deal with any minor emergencies. The rest should be placed in a higher-yield, but still readily accessible account. A CD won’t do; you don’t want your reserve locked up for that long. Any other sort of investment is even worse. What’s left?
Fortunately, the Internet has brought us the online high yield savings account. Head over to Bankrate.com and check out the various offerings from ING Direct, HSBC, and others. Pick one that you like and move most of your cash reserve there. Now, instead of 83 cents your five grand will bring you in twenty bucks or more each month. The only drawback is that to get at that money you have to have it transfered to your local account, which can take a few days. That’s why you still want to keep a grand or two in what I call the ready reserve.
What you are developing here is financial defense in depth. You have a ready reserve of modest size, with just enough cash to meet immediate and minor emergencies. That buys you time to tap into the larger reserve, which in the meantime is generating noticeable amounts of money for you. Together, they buy you time to get back on your feet in the event of a financial hardship, without going into debt or ruining your credit (or worse, going hungry).
There are some further variations we can add to this basic theme, but that’s enough to get you started. If you don’t have a reserve now, get saving. Even a little money in the bank can be very soothing, and a healthy savings account will help you sleep at night when the chill wind finally blows and you find yourself facing a pile of bills and no other way to pay them.