Save for the Future
A part of all you earn is yours to keep. It should be not less than a tenth no matter how little you earn.
—George S. Clason
If you’ve ever felt as though some kind of invisible force is conspiring against you to make sure you never get ahead, you may be more right than you think.
You have two enemies with a single purpose: to destroy your contentment and make it difficult, if not impossible, to spend less than you earn. Their names are Fear and Greed. They’re liars and thieves and will go to amazing lengths to undermine and sabotage your efforts to take control of your money.
In this chapter we take on our enemy Fear, that will do all it can to make sure that you never find contentment. This enemy will stalk you and keep you in its grip using worry, anxiety, and frustration to beat you down.
Fear makes you worry about everything from running out of money to getting fired. Fear scoffs and insists that you’ll never get out of debt, that you’ll have to work until you’re 85, and even then you’ll probably outlive your money and end up living under a bridge.
Financial fear leads to stress, depression, insomnia, and worse. It can mess with your mind and lead you to think irrational thoughts.
Fear is a strong enemy but quite a weakling compared to the power you have to defeat it.
It’s time to knock the life out of this first enemy, Fear.
Rule 2: As you receive income, transfer 10 percent of it into long-term savings.
I love Rule 2 for its simplicity and power to disarm fear and worry. The most straightforward of all 7 Rules, Rule 2 is almost a no-brainer. Simple math and a dogged determination are all that is required.
I understand that if you are one who really wrestles with money fears, this might sound too easy. It is simple, you’re right about that, and it works.
Rule 2 might also sound scary if you’re already struggling to live on 100 percent of your income. How can I expect you to keep up but on 10 percent less? Don’t worry. There’s plenty of credible data out there to suggest that if you are not taking good care of your money, at least 10 percent of your income is leaking away undetected. Good management can plug the leaks to recover the money required to apply Rule 2 to your life.
The Antidote for Fear
The antidote for financial fear is money in the bank. It changes everything because you lose that broke feeling.
Money in the bank changes your outlook because it changes your attitude. A nice stash of cash, tucked away in a high-yield savings or money market account returns big doses of peace of mind.
(You may have just chuckled at my use of the words “high yield” referring to savings accounts these days when interest rates are so low as to be almost nonexistent. It is a relative term that refers to a category of savings vehicles that do pay a higher rate of interest than what you’ll find at a typical bank or credit union.)
Money in the bank creates margin. Margin helps you to think more clearly and to make decisions that are not driven by fear. As your savings grow, so do your options. And with options come hope for the future.
I have come to the conclusion that people are fearful in direct proportion to how prepared they are to go through a season of financial hardship. Those who have no money in the bank and just enough food in the house to get through the week feel as though they’re sitting on a time bomb.
They’re terrified and worried sick because instead of saving money, they’re racking up debt, which just makes things all the more terrifying. They’re just barely hanging on from one paycheck to the next. If I could share with them some of the mail I’ve received recently from ordinary people who have suddenly found themselves unemployed after following Rule 2 for many years, I’m quite sure I’d have their attention.
One family told me how they added up their savings and realized they had enough money to live exactly as they had been living for at least six months. If they made some sacrifices, they could last for a year without tapping any retirement funds.
The feeling of freedom they described was amazing. Knowing they were prepared financially, they could more easily deal with the emotions and challenges of losing the family income. They viewed it as an adventure, not a catastrophe.
In this particular family, the father, who was the sole breadwinner, didn’t feel an enormous pressure to jump at the first job offer he could find. Because they were so well prepared for this upheaval, he had the option to hold out for a job he wanted rather than one he might have had to tolerate just to get back to work. He did find a new job after just three months, and amazingly because the family pulled together and cut out all unnecessary spending, they didn’t even touch their savings. But knowing it was there if needed, they related how they were more willing to make big sacrifices just to see how long they could survive on the breadwinner’s unemployment check.
Self-Reliance
Saving money strategically and with purpose does more than accumulate money in a safe place. It develops character traits of self-reliance and financial maturity. And patience.
There was a time when people had no choice but to prepare for their own emergencies. They had no safety net, also known as a credit card, to cover them when things went wrong.
The world changed in 1950 when Frank McNamara invented the first multi-use credit card, Diners Club Charge Card. Seven years later at the age of 40, McNamara died having seen his invention expand to nearly one half million Diners Club cardholders. I’m sure that even McNamara would be shocked if he knew where his idea has gone 50-plus years since he checked out.
The credit card changed the world in terms of self-reliance and the advancement of personal entitlement. But more than that, it blinded us to what should be instinctual—the need to save for the future as a matter of survival.
We’ve come to accept credit cards as the way to deal with emergencies. That’s how I lobbied to get my first credit card. I needed it, just in case of an emergency. I wouldn’t be surprised at all if that’s the reason you got one as well. Most people have bought into the marketing hype that the way to prepare for financial emergencies is to have plenty of credit available.
Survival Instinct
All of creation has been designed with the will to survive. That is especially fascinating to study in the animal world. Who hasn’t seen squirrels and ants storing up during seasons of bounty in preparation for lean times ahead?
We humans are endowed with survival instincts, not unlike animals but with at least one distinction: we can think and reason. And ironically that, it seems, has become our downfall when it comes to keeping our financial survival skills intact.
Relying on credit cards to cover us in emergencies may seem like a quick solution to the problem. But it only feeds fear and worry, because instead of lightening the financial load, it increases it, opening the door to more fear and worry.
What Went Wrong?
I place a great deal of blame on the consumer credit industry, which has managed to brainwash an entire society into believing that saving money is not a priority.
The message of consumer credit is, “Go ahead, spend what you have, get all you deserve. Don’t worry about anything! We’ll be right here to help out if you experience some kind of emergency. You need our credit card so you will be prepared for emergencies. You work hard, there are so many things in life to be enjoyed, so go ahead and live it up!” Granted, I’m no ad writer, but you get my point.
Don’t get me wrong. I am not saying that no one saves money. In fact, I wouldn’t be at all surprised if you have some kind of retirement account somewhere that you think of as a savings account (it’s not). And maybe a jar or two of coins, a stack of US savings bonds your grandparents stuck in a shoe box, or even a savings account plus some CDs at your bank or credit union. Good. Really, I applaud your efforts. But that doesn’t mean, necessarily, that Rule 2 is alive and operating well in your life.
Saving for the future needs to find its way back to your natural instinct as a responsible human being. You cannot continue to spend all that you earn (Rule 1). You must save systematically for the future as if your life depends on it (good, you recognized Rule 2). It just might.
Rule 2 in Action
When you receive money from any source, before you think about spending it, transfer 10 percent into your long-term savings account—no questions, no excuses, and no exceptions. Don’t think, just do it. Anyone can put money aside, at any level of income. You just have to do it. Saving money is simple. In no time this action will become a habit that you repeat so often it becomes automatic.
Rule 2 is not fulfilled with contributions into your retirement account, like a 401(k). This 10 percent comes off the top of your take-home pay—the money in your possession over which you have control.
Let me stop a moment to define a few terms. When I speak of Rule 2 savings as “long term,” this distinguishes these funds from money you may be saving to buy a new sofa or for your family’s summer vacation. That would be more short-term savings and a matter we see in Rule 4 to come.
Your Rule 2 long-term savings should be seen as insurance against big, serious emergencies that may be in your future: losing your income, an expensive medical event, or some other surprise emergency expense that hits hard.
Retirement accounts, such as a 401(k), 403(b), IRA, and types of “tax advantaged” accounts (meaning that you are saving pre-tax dollars) are not savings accounts because the money is out of your reach now and until you are 59 1/2. These accounts hold your retirement income—money you will need much later. Resorting to getting your hands on the funds ahead of time would be very costly to you, and a downright terrible idea. You do not want to think of tax-advantaged accounts as your source of income during times of unemployment or some other way to deal with a financial emergency. That is the role for your “long term” savings, which you can think of as your emergency fund (or your Contingency Fund, if you are part of Debt-Proof Living).
Make It Easy
The purpose of Rule 2 is to create a lifelong habit of saving for the long term, starting with an emergency fund.
Your long-term savings needs to be kept in its own account where the money is safe, easily available to you in time of dire emergency, and subject to earning the highest rate of interest available.
Safety. You want your money safe from outside thieves, from accidental loss, but safe from you too. That means you don’t want to keep it at home where making loans to yourself might be a little bit too tempting. You want your account in a federally insured bank or credit union, which protects your money from institutional failures, up to $250,000.
Availability. This requirement precludes you keeping your emergency fund in an investment vehicle like the stock market, collectibles, or other type of account that exposes it to risk and would require time to liquidate.
Interest-bearing. You want an account that is earning the best rate of interest possible, but not at the expense of your emergency fund being safe. You need to find an account with a higher rate than you’ll get at the typical brick-and-mortar walk-in bank.
Online savings banks offer an excellent place for long-term savings. In fact, this is where you will find the so-called “high yield” rates. Online savings accounts meet the criteria I have stated above and add a fourth: convenience. Online savings banks offer free FDIC-insured accounts. These accounts are tied to your current checking account no matter where that bank is.
I am a huge fan of online savings banks and recommend that you use this for your Rule 2 savings because online banks offer simple banking, great rewards, convenience, and almost no hassles (no bank is perfect).
These days, as big banks are nickel-and-diming their customers with fees, fees, and more fees, online savings banks remain fee free. Interest rates are relatively higher than the big banks and customer service is far superior.
Online banks don’t have tellers or branches so they have little overhead. That allows them to pay more interest and offer free accounts. The way that you access an online savings account is via the internet, or by mailing a deposit in a pre-addressed envelope.
How to Open an Online Savings Account
You don’t have to switch banks to get the best savings account for your long-term savings. The way it works is that your online savings account gets linked to your current checking account, making transfers back and forth easy and very convenient.
If you have never banked online, you may be concerned about whether it’s safe. Or you may be intimidated because it requires that you share your personal information online. Once you come to understand how to open a savings account online and discover the high-tech security measures these banks use, you will find it to be simple, at least as safe as a regular bank, and a rather convenient process.
Once you identify the internet bank where you want to open your account, you are ready to tackle opening an account. Generally, all of these banks follow the same steps to open an account.
When you visit the website of the online savings bank you have chosen, look around. You should see a button, link, or banner that prompts visitors to open an account. Click on it and you will see a form where you fill in your personal information, such as your name, address, email, phone number, and other identifying information. You will also be prompted to set up a log-on name and password to access your savings account online. As a standard procedure you will be asked to agree to the terms and conditions of the bank practices. Once you do this, you have completed the first step. Your account is now open.
Activate the Account
Account activation requires you to verify information to prove you are the person who just opened that account. It may be as simple as supplying the bank with your driver’s license number or Social Security number. Some banks send a text message to the cell phone number you supply or to your email address with a request to reply to verify that you are the person who actually opened the account. Other banks may have a representative call you on the phone to verify the information verbally. It is typically a quick process whatever method is used.
Fund the Account
Once your account is open and active, you will be prompted to complete the information on how you intend to fund the account. Typically, you can link this new account to your existing checking account. Simply add the routing number and bank account number for another bank for that account, then transfer funds from one account into the other. It is a slick process. Or if you are more comfortable, you can mail in a check or money order to fund the account. Some banks now offer mobile deposit, which allows you to use your smart phone to make a check deposit and adds another layer of convenience.
It takes ten minutes or less to get an online savings account set up, activated, and running.
I am particularly fond of INGDirect for its user-friendly website, ease of use, and stellar customer service. They make it so easy to set up an account, transfer funds, and manage a savings account.
Here’s how it works: go to INGDirect.com and open a new Orange Savings Account. You will need to give them your current checking account number and your bank’s routing number (it’s on the bottom of your checks—they show you where to find it). Once active, move some money from your checking account into your new savings account to get it started, and you’re all ready to go.
Make It Automatic
Any time that you can automate your finances, do it. If you try to remember to transfer money into your Rule 2 account every payday, for example, you might remember, but chances are pretty good that you won’t. Or you’ll be a few days late. Automatic transfer is a superior option. Set it up by creating a regular automatic withdrawal from your checking account into your online savings account. It’s simple and will allow you to put Rule 2 on autopilot.
First figure out the exact dollar amount you want transferred, rather than a percentage. That’s simple enough. Just be careful when you select the date on which this automatic withdrawal will occur.
Let’s say that you get paid $2,000 net on the 1st and again on the 15th of each month. Your paychecks are deposited directly into your regular checking account on those days. Don’t set up your automatic transfer for the same day as you’re paid. You want to allow for a little wiggle room in case payday falls on a holiday and to allow for other such delays. Create your automatic transfers of $200 each to occur on the 2nd and 16th, or a schedule you’re comfortable with.
That’s the way Rule 2 looks in action. Of course you can make manual transfers for other sources of income that may not be as predictable.
While you might miss the money for the first couple of months, I promise you that soon you won’t even think about it. It will be like money that is deducted from your paycheck for taxes, FICA, and other items withheld. It’s human nature to not miss what we don’t see.
How Much to Save
Your emergency fund needs to contain at least enough money that you could pay all of your bills and monthly expenses for six months without a paycheck. The principle is this: if you become unemployed or for some other reason your income is temporarily cut off, you need to be prepared to take full responsibility for keeping all of your bills paid and your life intact until you can find another job. That’s the kind of emergency that this account is for, not for buying new clothes or going on a fun weekend vacation.
So how much money are we talking about? It’s different for every individual or family because it depends on your current expenses. Will you be eligible for unemployment benefits if you were to lose your job? Again, it all depends on the circumstances at the time.
You could take a lot of time to quantify and project, or you could simply multiply your current monthly expenses by six and consider that a good, round number for your emergency fund.
Consumer expenditure statistics from the US Department of Labor indicate that the average annual expenditure per consumer unit, which is similar to a household, is $49,067, as of 2009 (the most recent year for which data is available). Doing a little quick math in my head indicates the typical household needs $25,000 in cash reserves to be held for major emergencies.
While your household expenses may be higher or lower than the average, there’s no doubt that even three months’ worth of expenses is a big number ($12,500 for this average household).
If you currently have no savings to speak of, I wouldn’t be surprised to hear you say, “I can’t come up with that kind of money.” I understand, but don’t dismiss the possibility or the necessity too quickly. You really don’t have a choice when it comes to preparing for the future. So let’s figure out how you can do this, no matter your current situation.
Why So Much?
The amount of money required to fund a proper emergency fund is certainly significant. You might be tempted to dismiss the six months’ expenses as overkill. But we live in uncertain times with uncertain economies. Corporate loyalty is a thing of the past, and unemployment can happen unexpectedly, usually at the worst possible moment. Likewise, emergencies can be expensive, and there’s never a good time for these things to happen.
The secret to building your emergency fund is breaking it into bite-size goals. You wouldn’t think of sitting down and eating an entire sausage in one gulp. But if you cut it into thin slices and take them one at a time, with enough time you really can eat the whole thing. The same principle works with any seemingly insurmountable task. Using the “sausage method,” break it down into small slices and short goals.
How much would it take for you to keep your life together for two weeks without a paycheck? That should be a much smaller amount, and a goal that is easily achievable.
Once you reach the two-week mark, do a cartwheel, then go for three. Then a month, then two months. Soon you will be fully funded for the recommended six months and you’ll be astonished by what you’ve accomplished.
Here’s a small bonus you can look forward to: saving money can become addictive, and I do mean that in a good way. As your contentment grows and your fears subside, your confidence will soar. And your financial picture will begin to reflect this change of attitude and heart.
Saving 10 percent of your net income is a lifelong habit. You will always save the first 10 percent from any income that you receive, although you will not continue to funnel your savings into your emergency account. Once your emergency fund is fully funded at the level that you determine is right for you, your Rule 2 savings will have other jobs to do until eventually you are channeling the full 10 percent into investment vehicles that will speed up the time it takes for you to reach that crossover point where you reach financial freedom (see figure 4.5, page 47).
This Is a Must
No matter your situation—even if you are up to your eyeballs in credit card debt—you must have an emergency fund. Every household needs one. The very foundation of our money management plan is liquid cash, meaning that in 24 to 72 hours you could get your hands on money you have earmarked for specific emergencies. Without an emergency fund you will spin your wheels trying to get out of debt because every time something unexpected comes up, you’ll feel you have no choice but to run for the credit cards. An emergency fund creates margin and allows you to step away from the edge.
Your attitude about your emergency fund will either make or break it. If you see it as a pool of money to be used at will for anything that suits your fancy at the moment, you have completely missed the purpose of an emergency fund. If and when the funds are used for the purpose for which they have been set aside, they must be quickly replaced. Maintaining an emergency fund provides much-needed space between you and the financial edge.
Supplement to Get Going
You may be anxious to get your emergency fund growing at a faster rate than 10 percent of your net income will allow. Good. Realistically, you need to save at least $1,000 as quickly as possible. Then keep going to $2,000 and on until you reach your goal.
To get there faster, find ways to dedicate $5 a day to the effort. Do that and you’ll boost that account with an extra $1,825 in a year, or $9,125 in just five years.
Here are some other ideas for how you can supplement your efforts to get your emergency fund funded more quickly.