The Power of Padding (your checking account)
Over the past 3 years, my wife and I have done a lot to improve our financial wellness, from online banking to Roth IRAs (however small the contributions).
But perhaps the single most useful things we've done was also probably the simplest (note I didn't say easy -- running a marathon is very simple: you just run for 26 miles; that doesn't make it easy). It was a tip we'd heard in one form or another before, but really picked up from the excellent book, All Your Worth.
The tip? Pad your checking account with an extra $1,000. Most financial books recommend saving 3-months' worth of living expenses as an "emergency reserve". I don't personally know anyone under 30 who has actually managed to do that, though I'm sure they're out there somewhere. And if they are, they have little use for financial advice books, since they probably wrote one. But $1,000? Sure it took us longer than I'd prefer to admit, but we did it. And it made a world of difference.
No more worrying about bouncing checks, or rushing to make a deposit before a bill was due. Just a warm fuzzy feeling knowing that if the car broke down on a road trip and needed a new radiator, we were prepared to handle just such an emergency without a credit card.
The (admittedly minor) contribution I'd like to make to the suggestion is in the mechanics of how to fool yourself into forgetting that $1,000 is there. It's very simple: just make an entry in your checkbook as if you'd written a check (or actually write the check if you'd like) to "Cash Reserve" or something similar. In fact, if you don't currently have an extra $1,000 to put into a reserve, then writing checks in smaller increments for a few months might be a fairly painless way to build one up. This way, when you balance your checkbook, you don't have to remember to add (or was that subtract?) the extra money -- it just shows up as an uncleared transaction.
In the grand scheme of things, it was a pretty minor thing. But it was a great milestone to reach, and gave us the motivation to go further toward setting and reaching our financial goals.
Labels: banking, couples finance
posted by Andrew Savikas @ 9:29 PM
2 Comments
2 Comments:
Andrew,
At 26, although I do not have fully three months of expenses in a liquid account, I am well on my way. As you mention, it is embarrassing to think about how long it takes to save that much, but some of the extra time has been a validation of the exercise--more than once, I've dipped into the extra cash to cover one of life's road bumps.
The reason I'm commenting though, is not about how much one chooses or is able to save, but the unmentioned benefit of saving exactly three months of expenses. When I set out on my savings goal, my first step had to be to calculate just how much three months worth of expenses actually was. Actually going through every monthly expense was an amazing exercise.
Aside from just tallying it all up (and ending up with a dizzying number) I made the effort to evaluate each expense. T-Pass? That's a requirement. Netflix? Not a requirement, but I get more than $18 worth of value out of the membership. In my process, I discovered that my gym membership had climbed from $60 to $80 (I switched in a hurry) and that I could easily live with the $17 Vonage plan rather than the $24 unlimited plan.
In the end, I cut my monthly expenses by about $100, which had the dual benefit of lowering my target savings, and increasing my ability to sock cash away. So regardless of your ultimate goal, if you are saving to offset future expenses, I highly recommend gaining an understanding of those expenses, and maybe lowering them too.
That's a great point, Colin. Congratulations on being so far ahead of the curve on getting your finances in order.
The exercise you've described is very similar to what All Your Worth walks you through -- classifying everything as a "Need" (50% of take-home), "Want" (30%), or "Savings/Debt" (20%). They make the (correct) point that cable TV and new clothes are not really "needs" -- if you lost your job, you'd probably do just fine without either.
By ensuring that you can completely and comfortably survive on just 50% of your take-home pay, the size of that cushion (and the impact of a significant paycut from a job loss or injury) both get a lot smaller.
On the other hand, they also acknowledge that when times aren't so dire, it's very important to spend a reasonable amount on things you just plain want, without feeling guilty about it. You don't sound like you need much help, but it's a good read anyway.
Cheers.
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