A Savings is a keystone in any good financial plan. Having one is good practice. How do you know if your s is right for you? Personal financial plans are personal, so ensure that you are building the foundation for you and not based solely on someone else.
Is Saving 3-6 Months of Expenses still valid?
Many advisors have a quick go to of saying, “Save 3-6 months of expenses.” That advice is better than nothing, however why do they say that? What assumptions should go into that?
I’ve heard this time and time again from almost every financial planner and speaker out there. Do they even know why they are saying this? Well I can not answer for them, but I want to dive into how much you should actually have as a savings. I also want to bring to light some instances in which may require a deviation from this norm.
Why Have a Savings?
First, lets understand why we save. We primarily have a savings as an account that can carry us through unexpected occurrences. Things that could be unexpected are: a loss of a job, disastrous event such as a natural disaster, or even just as something as a large expense such as auto repair.
Second, lets also differentiate that these savings are not investments. This money is what you want in a high yield savings account, short-term certificate of deposits (CDs) or the like; this way it is liquid within 15-30 days with no loss of principle.
So How Much do I need?
For those who are employed, they would do well having around 6-9 months of savings. This is to cover an event such as job loss. Looking for a new job can take anywhere from 2-8 months (based on current averages, and may vary depending on your field). To determine your need, research your field and look at what averages have been to get a new job.
For those with a very dependable job such as government workers or others that fit into this category, your income is more stable, and are not as subjected to private industry swings. Because of this, you may only need a 1-3 months of savings. If you have kids, or other special circumstances you may still want more than 3 months of savings.
For self-employed (including a contractor of freelance worker), others that may be in or entering retirement, or if you have a commission only job such as a realtor, then a larger savings may be needed. For these individuals your need might be anywhere from 6 months-24 months depending on income stability.
Not a One Size Fits All
So, as you can see there isn’t a one size fits all, and everyone should take into consideration their situation. Other things to consider is how much debt you have; with little or no debt, you may not need as much.
Should I use Expenses or Income?
If you operate off of a monthly budget and stick to it, your bills are very consistent than having “so many months of expenses” may work. Personally, it doesn’t matter whether you use income or expenses to determine how much you need to save. By the time you are in a situation that would require a savings, you may not have scaled back to basic necessities. Second, and let’s be honest, many people don’t know how much their expenses are each month. They just know that they are living somewhat within their means. Whether or not that is the case, I find it very easy to use gross income. Most of the times you can find this number on your pay stub and then just multiply it by the number of months you determine you need.
Keep this as the Foundation of your Plan
Once you have a savings, you may be very tempted to “get smart” and try to invest it.
Hold on right there.
Remember this is a type of “insurance.” This ensures you have money when you need it. If anything, keep at least one month in your checking, and keep the rest in a high yield savings or money market account. This way, your money is at least keeping up with inflation (for the most part) and is easily transferred to your checking account when needed.
Lastly, stick with it, the goal is to build your savings to create a foundation as a stable footing in your financial plan. Once that is complete, you can continue on to invest and build wealth at ease.