STRATEGY #8 TO SURVIVE A DOWN ECONOMY
By Kevin M
A robust bank account has traditionally been considered to be a desirable asset to have, even a sign of prosperity. But in the past 20-30 years, with easy credit and almost predictable double digit returns in the stock market, conventional thinking came to view traditional savings as boring and unproductive. Being “fully invested” became the new mantra.
But given the current state of the economy, and of credit in particular, it’s a good bet that many people followed the new directive to their own detriment. Alas, credit lines can be shut down like a faucet, and stocks and mutual funds are really speculative investments and not true savings.
In 10 Ways To Survive a Down Economy (published on Christianpf.com June 1) we listed ten strategies to help you deal with the bad economy. Our topic for today, Strategy #8:
”Accumulate savings. Make it a lifetime activity. This is the best insurance you can have against sudden income disruptions. At the risk of being redundant, you will need to lower your cost of living in order to do this.”
Previous generations viewed savings as a necessary part of survival, almost as important as earning a living itself. But today is a new world, with new rules—or is it?
Playing fast and loose with the definition
It isn’t ridiculous to consider that recent cultural understanding of savings has distorted the term beyond it’s practical purposes. So what are savings?
First, let’s take a look at what true savings aren’t:
- Stocks or mutual funds
- 401k’s or other retirement accounts—this is doubly true if those accounts are primarily invested in stocks and mutual funds
- The equity in your house
- The unused portion of your available credit card limit or home equity line of credit
- A certificate of deposit or other cash asset that’s been pledged as collateral for a loan
In one way or another, each of these vehicles has come to be viewed as “savings” in many quarters. But stocks and mutual funds rise and fall in value, and the declines often coincide with the need to withdraw funds, making their reliability worse than suspect. Retirement plan withdrawals have tax consequences, and both home equity lines and credit cards are no longer as lucrative as they were just a couple of years ago—and plunge the user deeper in debt to boot. And a pledged asset is essentially canceled out by the liability attached to it. None of these represent true savings in the practical sense.
The only true savings then is, well, savings! Like a boring savings account, money market fund or short term certificate of deposit (CD). People look at the interest rates being paid on these accounts and bristle at committing money at such low returns. But the central point of savings isn’t return on investment, but safety and liquidity. Savings shouldn’t be primarily an investment, but a reserve against hardship. Recent events in the economy are showing that hardship isn’t necessarily as far away as we once thought.
In Start and Grow Your Nest Egg Even if You’re Broke we listed several ways to build up a healthy savings balance in relatively short order, summarized as…
- Sell your stuff—the little extras hanging around that you don’t need any more
- Sell your bigger stuff—some major items you really love but don’t need
- Bank a bonus
- Take a part time job—temporarily
- Make minimum payments on credit cards and redirect the extra to savings
- Forego some luxuries until your savings reach a desired level
- Go on a spending diet—make an across the board cut in your budget, banking the cuts
- Take on a side project or contract job
(The list above is greatly abbreviated; you can click on to the original article for a more detailed discussion.)
The key is often in the startup; a quick build up can provide the motivation to keep the process going so that the accumulation of funds becomes a habit even for the person who’s never done it in the past. $50 or $100 a week can be a steady way to grow a bank account that already has a few thousand dollars in it, but if it’s the entire plan, it can require years to accumulate a relatively small stash. The process is as much psychological as it is financial, and early success tends to feed on itself while gradual accumulation has the potential to be derailed early in the process.
How much is necessary?
Many financial planners and counselors suggest having a savings cushion equal to three to six months of living expenses—the lower end being more appropriate for salaried employees, the higher for self-employed and commissioned workers. But these are just general guidelines.
In truth, how much you should have is totally subjective. Start with the question, “how much would I need to have safely tucked away that I’d feel reasonably secure in my financial position?”
The answer to that question will be different for everyone. One person might need a 12 month reserve to feel secure, another might be good with just three.
While it’s true that unlike the Great Depression, today we have unemployment insurance to provide partial insulation from job loss, imagine how much more secure you’d feel having a three, six or 12 month income reserve in addition to a 26 week (or more) unemployment benefit?
Once you reach the desired savings level, it will be time to begin accumulating funds for that other form of longer term savings—investing. And once your short term is covered, saving and investing for the long term will be that much easier.
Recent developments in the economy warrant a return to a more traditional view of savings, establishing it, growing it and considering it to be purely a survival asset and not viewed merely as part of an overall investment portfolio. In today’s environment, a job and income loss should not only be expected, but planned for. Pure savings represent perhaps the best insulation possible.