It often seems that either you’re a saver or you’re not, there’s not a whole lot of middle ground. The main difference between the two is often a simple matter of not getting started. It all begins with an emergency fund, that basic grubstake that you have available for those times when you have more expenses than paycheck.
Savers versus non-savers
Savers tend be saving money on a continuous basis, starting with an emergency fund but always building up their cash positions no matter what else seems to be happening in life. Over time, their prosperity grows and they have little reliance on debt apart from a home mortgage and an occasional auto loan.
Non-savers are the preverbal hand-to-mouth survivors, living from paycheck to paycheck and covering the holes in their budgets with credit. Over time, their debt burdens grow since they have no savings to tap, and none to grow. Financial independence is more of a wish than a plan in progress.
It’s true that literally millions of people survive as non-savers, and some do surprisingly well for long periods of time. But it’s a tough life living on the financial edge year after year. There’s a lot of uncertainty accompanied by stress and the fear of an income interruption. And the future is always an open question.
Last week I wrote about using a savings snowball to build a long-term comprehensive plan of savings and investments. But today we’ll cover a simple way get started on building that most basic of savings accounts, an emergency fund.
If you’ve never had an emergency fund it can be a serious hurdle to build one from the ground up. But once you do, you have the foundation upon which all other forms of savings and investments can be built. Get an emergency fund up and running, and all the other savings and investment plans will follow more easily.
How the Ten-By-Ten Method works
One aspect of building a credible emergency fund is that it has to happen pretty quickly. For non-savers, reaching a savings goal is crucial, otherwise they’ll abandon the effort. To do that with an emergency fund, you’ll have to reach you goal within one year. This is where the Ten-By-Ten method comes in.
At a minimum, your emergency fund should be sufficient to cover 30 days of living expenses. Not only will that cover you for the first month of unemployment, but it will cover most emergency expenses that will crop up in between.
The Ten-By-Ten method works by saving 10% of your take home pay each month for 10 months—hence “ten-by-ten”. After ten months of saving 10% of your net income, you’ll accumulate 100% of 30 days living expenses in your emergency fund.
To make it work, you’ll either have to increase your income by 10%, cut spending by 10%, or some combination of both that allows you to save 10% of your net income.
There are different ways to do this, and you can choose which ever way is most comfortable for you.
You can take a part-time job. You can start a side business, but in order for you to do this you’ll have work in a business that you know well and have a ready pool of potential clients. You can also ask your employer about side projects that need to be done that you might do either by working overtime, or on a contract basis. Or perhaps you can pick up some contract work at other companies.
What ever income earning route you take, you’ll only have to do it for ten months. But be certain that you put all of the extra income into your emergency fund. In ten months you’ll reach your goal.
Working a second job or business venture can be taxing on a schedule and on a person’s energy level, and many find it easier to cut back on spending. Your goal will be to reduce your expenses by 10% each month for ten months, then faithfully bank the savings in your emergency fund.
You can usually do this by cutting soft costs, like groceries, entertainment and eating out. For example, if you spend $30 a week eating lunch at fast food restaurants during the workweek, you can save $120 a month by brown bagging your lunch instead. Over ten months, you’ll save $1,200 with that change alone.
Fast forwarding your emergency fund
It’s sometimes possible and often desirable to fast forward your emergency fund by banking windfalls. This can be money from a bonus or the sale of personal belongings (furniture, appliances, jewelry or sporting equipment).
One of the best kick starts you can have is to begin your ten-by-ten upon the receipt of your income tax refund. With the average income tax refund being over $3,000, you won’t need ten months to reach your emergency fund goal.
The payoff of having an emergency fund
Once you have at least 30 days of living expenses in your emergency fund, you’ll start sleeping better at night. You’ll feel better about your finances in general, because you’ll have created some margin in your budget. You’ll have peace of mind, and that’s the beginning of all kinds of good things.
Equally important, you’ll have laid the foundation for further savings—near term savings goals, like the down payment on a house or anticipated major repairs—or long term goals like retirement and a college education for your children. And most important, you’ll have converted yourself from a debtor to a saver—and that’s when really good things start to happen.
And it all starts with freeing up 10% of your paycheck each month.
Do you know of any ways to create and build an emergency fund quickly?