Tag: emergency savings

Why We Love Rules of Thumb…Even Though They Suck

For a lot of us, when things get complicated and we have big decisions to make, we secretly want someone to just tell us what to do. I never liked when my parents did this when I was a kid, but now? Please do! Someone?.anyone? Help!

When it comes to career advice, sustainable living, or any other complicated situation, we want a simple, quick answer from a source we trust. Managing our money is no different. It can feel incredibly daunting to make decisions about our financial well-being, especially when making a mistake can cost us. So the answer to this dilemma?

Rules of thumb for common money woes (and when to bend them)

Rules of thumb are everywhere. They’re simple, tweetable, and make for great tidbits you can share at your next cocktail party to convince your friends you know what you’re talking about. (I’m guilty of using them myself.) But they can also be problematic: Rules of thumb, by definition, are one-size-fits-all that don’t leave much wiggle room. There will inevitably be situations when they just don’t quite fit. And there will be other situations when they are outright wrong.

Their other downside? Rules of thumb rarely directly address the real questions we have about money. Am I really ready to buy a house? Should my partner and I combine our finances? Can I afford to take a vacation? What would it mean to quit my job and go freelance? Most personal finance decisions are truly personal. It’s all about what’s right for you and your particular situation. No rule of thumb can answer that.

Rules of thumb rarely directly address the real questions we have about money.

So should we start ignoring these catchy rules? Not quite.

Here a few examples that truly are worth paying attention to and some ideas on when you might want to bend the rules:

50/30/20 Budget:

Spend 50% of your income on needs (housing, bills, transportation to and from work), 30% on wants (dining out, shopping), and the remaining 20% on financial priorities (paying more towards your debt, starting an emergency fund, saving for long term goals).

When to bend the rule:

This is a neat little formula but many people may find that their current budget doesn’t fit into these boxes. Maybe you’re a new grad who moved to an expensive city and earn an entry level salary. Your needs would likely eat up far more than 50% of your budget. Maybe you’re planning to take a year long sabbatical to travel around the world. You may need to devote far more than 20% of your pay to this goal in order to make it happen.

If you don’t fit into this formula – it’s okay! Find your own balance that makes the most sense for you. Don’t feel guilty about making tradeoffs either. A cheaper apartment means more room for dinners out with friends. But for someone else who values nights at home in a comfortable living space far more, a higher rent may be just fine.

3-6 Month Emergency Fund:

Save the equivalent of 3-6 months of expenses in a savings account for emergencies.

When to bend the rule:

There are plenty of people who would sleep much better at night with 9 or even 12 months worth of spending money saved in their bank account. Some of them may have experienced a layoff followed by a long job hunt, others may have very lumpy income from freelancing gigs, and then there are those that are just plain conservative.

On the other hand, there are those who are more comfortable with taking on a little risk, some who need their extra cash to pay down high interest credit card debt, and some that have other safeguards in place like disability insurance, a high earning partner, or multiple passive income streams. These people may be comfortable with a much smaller emergency fund than most.

Think about your own personal situation and how much you would need to pay for an out of the ordinary medical bill, or to cover your expenses if you lost your job. No one can assign you the perfect number that would save you from any potential financial disaster. Always leave enough of a cash cushion to cover immediate needs in an emergency and have a plan for how you would cover extra costs should they come up.

Related:? Emergency Savings – Is It For Me?

20% Down on a Home:

Always put down at least 20% of the purchase price when buying a home.

When to bend the rule:

Coming up with a down payment is the biggest obstacle many people face when it comes to home ownership. A down payment of 20% has been the standard, however, it is in no way required, and for many it may be unrealistic. FHA loans require a down payment of at least 3.5%, some conventional loans require only 3%, and there are a number of other housing programs that require no down payment at all.

It’s important to know that a smaller down payment often comes with extra costs like a higher interest rate on your mortgage and private mortgage insurance. You will also have less equity in your home at first. On the flip side, less of a down payment means more money available to cover closing costs, pad your emergency fund, or invest for retirement. It can also mean you move into your dream home much sooner. The moral of the story here: there is no one right way to buy a house!

Rules of thumb can be a great jumping-off point for figuring our your finances, but ultimately the way you manage your money is up to you. There is no one-size-fits-all approach that’s going to work for every situation; so rather than try to conform to a rule of thumb, explore your options and decide what makes the most sense for you. Just because a simple rule won’t provide you with all the answers, don’t be intimidated to take action anyway. A dollar saved, paid towards debt, or invested is always better than nothing.

Related:? How to Save for a Home Down Payment


Photo by Scott Webb

Tags: , , , , , , , , , ,

Are You Losing Money By Saving?

If You Have Credit Card Debt, You’re Losing Money By Saving

It seems counterintuitive, but if you have credit card debt, you’re actually losing money by saving instead of paying down your debt. It may feel like you’re moving forward, but you’re actually moving backward.?People tend to compartmentalize cash and credit card debt and this can get them in trouble. While having cash in a bank account can give you peace of mind, this is an illusion?if you have credit card debt.

What You Think Is Happening

Graph going up

Related content:? What Credit Card Companies Don’t Want You to Know

The truth is, money in a savings account isn’t doing much for you. Even if it earns a bit of interest, that earned interest is easily dwarfed by the interest you’re being charged on credit card balances. Put simply, if the interest you’re earning on savings is less than the interest you’re charged on debt, you’re losing money.

  • The average interest rate on savings accounts currently ranges from 0.01% – 1.45%
  • Meanwhile, the interest (APR) charged on credit card balances could be anywhere from 14% – 22%.

What’s Really Happening

Graph going down

If you look at your credit card statement closely, you will notice a “disclosure box” that warns you how much interest you will pay if you continue to only make the minimum payment compared to how much you will pay if you raise the monthly payment enough to pay the balance off in 36 months (3 years).

It usually reads something like this:? “Making only the minimum payment will increase the amount of interest you pay and the time it takes to repay your balance.” The difference is quite shocking.?The credit card companies don’t disclose this information because they want to. They disclose it because the Credit Card Act of 2009 forced them to. You owe to yourself to check yours out.

An Illustration of the Illusion

Here’s an example of what saving $100 per month at 1% interest will yield compared to interest charged that you could avoid by allocating that extra $100 dollars to a credit card balance of $5,000 with 17% APR instead.

table showing financial impact of paying down debt v. saving

If you use the $100 per month to pay off debt, you’ll avoid paying $3,297 in interest charges over 3 years. If you invest the $100 instead, you’ll earn $35 after you pay taxes.

 

So, if you save $100 per month in a savings account for 3 years instead of throwing it at your debt, you will be left with all of $303 for your troubles. But if you allot that $100 to your credit card bill, you will save $3,192 in interest charges ($3,297 interest paid on the credit card less the $35 interest you would have earned in savings.) As you can see, the longer you drag out your payments, the more you pay in interest. You can customize your own personal configuration to check out how much you can save by?using this calculator.

Remember that the amount you save in interest charges on your debt is the same as earning that interest on your savings. In other words, don?t save money to earn 1% interest if you?re paying 17% on debt.

Related content:? Credit Counseling vs Debt Settlement

Don’t Build Emergency Savings if you have Credit Card Debt

While the idea of not having “emergency savings” in the bank may seem?scary, remember, your money isn’t helping you in the bank. But it?s helping the bank quite a bit though. The bank is loaning out your money to make money for themselves. Meanwhile, interest is accumulating quickly on your credit card debt, pushing you further and further into debt. The banks are double dipping and this should piss you off.

Paying Down Credit Card Debt Is An Excellent Investment

Savings accounts are poor investment vehicles. They simply do not pay enough interest to keep up with inflation. In fact, you would actually be hard-pressed to find an investment vehicle that could deliver guaranteed returns which are more than the interest you are paying on your credit card debt. If you look at it this way, paying down your credit card debt means you are getting a return which beats the market. Pretty cool, right?

Having emergency savings is a popular idea. But think about it. The odds that you are going to have an emergency are much less than the 100% certainty of paying a ridiculous amount in interest over time the longer you drag out your credit card payments. Paying down your consumer debt first will relieve you of chronic money problems and allow you to save more in the future.??

Rethink Your Strategies

If you can use some of your money allocated for savings to attack your credit cards, you will end up with more money in the long run. If you look at the big picture, your savings balance is not the safety net it appears to be when you have a huge liability hanging over your head that has the potential to cause you sustained financial damage.

Ideally, we want no debt and savings. But it’s really important to make eliminating consumer debt the first priority. You can’t really save money if the amount you are putting in is less than the amount that’s bleeding out. A boat that takes in water at a faster rate than you can bail is eventually going to sink.

Related content:? 5 Ways to Free Up Cash Without a Side Gig

 

Tags: , , , ,

Emergency Savings – Is It For Me?

Sounds like a crazy question, right? But the fact that over 50% of Americans have less than $1,000 in their bank account gives it a bit more weight. If you are a part of the majority that has no emergency savings, it might make you feel better that you aren’t alone here, but please don?t let it make you complacent.

What happens when we don?t have emergency savings?

Every time we hit a bump in the road, we have to reach for credit cards to bail us out. And when you’re already in a position where you have to reach for a credit card to put out a fire, the last thing you need is an additional monthly credit card payment, especially one that grows with compound interest. Clearly, you can see the spiral here.

Admittedly, saving hard earned cash to disappear problems isn’t as sexy as getting that new shiny thing, but the alternatives are worse. When you have cash backing you up, you have more options available to you when you’re in trouble, so you won?t have to sell a piece of your future to solve a problem. Think of cash as the hammer in your financial toolbox. You need it. We all do.

Related content:?Are You Losing Money By Saving?

Pros
  • Builds good money habits.
  • Gives you security and confidence.
  • Allows you more choices when problem-solving.
  • Savings accounts aren’t subject to the risk that investments are.
Cons
  • Savings accounts generally earn a lower return than investments.
  • Monthly fees at some banks can eat up interest earned.
  • Saving money could mean a change in lifestyle.
  • Budgeting to save forces you to take a deep look at how you handle money.

How much should I save?

Ask yourself how much you would need each month to survive if your income stopped abruptly. Ask yourself uncomfortable questions such as ?how long would it take me to replace my job?? The more difficult you think it might be for you to replace your income, the more you should save. Financial advisors suggest ranges anywhere from 3 month’s to 2 year’s worth of monthly expenses. But you are the best judge of your risk tolerance.?

Where should I keep my emergency savings?

The most important features of an emergency savings account are accessibility and growth. You want to be able to use the money immediately should you have to, but you also want to keep it in an account with the highest interest rate possible, and no monthly fees. It’s a good idea to keep an emergency savings?account in a different bank than where you do your everyday banking to avoid the temptation of dipping into it.?Online savings accounts can come into play well here as their interest rates are generally higher, and some have zero fees.

How do I start?

You may not be in a position to put very much aside at first, but don?t let this dissuade you from saving at all. The truth is, if you simply start by setting reachable goals, you will gain the confidence you need to continue. For example, set an initial savings goal of $1,000. Reach it. Then repeat it. Decide on a fixed?amount that you can spare each month. Can you afford $50 bucks? $250? Pay yourself first via direct deposit or scheduled transfer. Treat your emergency savings like a monthly bill, and pay it first.?Here are a few of the highest interest rate, no monthly fee savings accounts that allow you to automate your savings.

Online Savings

Min Balance

Fees

Interest

Ally

0$

0$

%1.25

Discover

0$

0$

%1.30

Alliant

5$

0$

%1.25

So, let’s put this in play here. Say you can save $100 per month. (That’s like $3.50 a day, you can do that, right?) With an interest rate of 1.30%, you’d have $1,000 in around 9 months. While that might not seem like much, if you put this in place today and forget about it, 3 years down the road you?ll have close to a $4,000 cushion to fall back on should something happen. $4,000 can at least buy you some time, or car repairs, and keep you from sinking into debt. So, just socking away $3.50 a day for 9 months can put you in a better financial position than most Americans. Think about that for a minute.

Related: What’s Keeping You From An Online Bank?


Photo by?Steinar Engeland

Tags: , , , , ,