There are really only three things you can save for: emergencies, major purchases, and wealth building. Throughout the year I have had conversations with all kinds of people and one thing I have found is that fundamentally, everyone has the same questions. When it comes to saving, the frequent question is “How do I know what to save at this stage of my life.” That’s a great question! After all, you have an infinite number of things you can spend on and save for, but a finite amount of income to allocate.
Here is how I would break out my savings by importance:
There are only a few things in life that you can count on for sure, things like, you know… death and taxes. You can also count on the fact that financial emergencies are going to come up – I don’t care who you are, eventually you are going to need to pay for something that was unexpected. This is the first thing you must save for. I call it an Emergency fund. You might call it a “Rainy Day Fund” or the “Hell and High Water Account”.
What ever you call it, you just need to have it!
So how much should you save for emergencies? A minimum of $1000. If you do not have a $1000 emergency fund right now, you need to go sell some stuff, or mow a bunch of lawns, or shovel a bunch of driveways to get it by the end of the month. I’m serious. A thousand dollars will be enough to cover most minor emergencies, but it won’t be enough for the big stuff like a job loss or injury. Your ultimate goal should be to have 3-6 months worth of household expenses set aside in the fund. Here is the other thing; you really need to have this account separate from your usual deposit account. If you have all your money in one place, you might have some temptation to use it for a 30% off sale at your favorite department store. Remove the temptation, create an imaginary barrier by holding your emergency fund in a different account.
Life is expensive. Washers and dryers, a furnace and air conditioning unit, a roof, a car… If one of these breaks down, it makes for a bad day, maybe even a bad week. It can even feel worse if you haven’t been saving to replace the major appliance (especially if you don’t have an emergency fund, see above). I suggest saving for major purchases along the way. For example, if you own a home it is only a matter of time before something will need to be replaced or repaired. I suggest saving 1.5% of the value of your home each year for those expenses. Set it aside at the same time you make your mortgage payment each month. If you have a $250,000 house, save $3750 each year or $312 a month.
Wealth building and retirement saving is third on my list. You really can’t focus on investing if you don’t already have emergencies and major purchases covered. You want to be able to have confidence and flexibility when you start to tie money up in investments – if you are worried about what you would do if something breaks at home, you really won’t be able to have the fortitude to execute in the wealth building arena. Your goal should be to save 16% of your gross income (before tax income) for retirement. That’s a pretty big number, but it is a goal. Here is how you can achieve it: Start with something more modest like 8% of your gross income.Then each year raise your contribution by 1%. You probably wont even notice the increase from year to year and before you know it, you will hit your goal!
Here is the deal guys. I know some of you are reading this and saying: “Yea, Andrew, that would be nice, but I don’t have any extra to save.”
I don’t believe you. You should really be saying “Yea, Andrew, that would be nice, but saving is not a priority for me.” HELLO! The only way you will do any of this is if you make the decision that you no longer want to live in crisis any more. You have to choose to do what it takes to move from doing what you have always done to doing what you wish you could do. If you establish an emergency fund, it will change your life. If you build wealth, you will change your family’s life. Only you can choose to take this path.
As my high school swim coach used to say: No Excuses, Just Results.