STUPID MISTAKE #2
Waiting till It Pours to Realize You Don’t Have an Umbrella
It wasn’t raining when Noah built the ark.
• Your teenaged daughter takes the car on a quick errand. Just to the drugstore and back, she assures you. Then you get the phone call. “Mom, you know the intersection of Third and Main? I was, like, going through the intersection, and the light turned too fast. Like, it went right from green to red. Well, like, the new car kinda has a big dent in it.”
• You’ve been working fifty-plus hours per week for as long as you can remember. When you’re not on the job you’re thinking about it or losing sleep over it. You desperately need a vacation—not a few days off to paint the deck, but a genuine, get-outta-town, mind-in-neutral, no-visiting-the-parents vacation to rejuvenate the mind, body, and soul. But to do it right would cost $1000 minimum—more like $2500 if you want to eat, sleep on a mattress, and use fixtures with plumbing—and the money just isn’t there.
• “We’ll just run some tests,” your doctor says. “Your insurance should cover it.” Sixty days later you receive a not-so-friendly statement announcing that the total for your procedures was $526.28, of which your health insurer has now paid its generous share, $28.78. The remaining $497.50 is up to you—and thirty days past due.
• Your father passed away a few years back and your mother’s vitality is failing. Soon she’ll need to move to a retirement center and perhaps its assisted-living facility. But her financial reserves are limited. She’s going to need help with the up-front costs and with her monthly expenses. You love her dearly and want to help. But with your present family obligations, where will you find the extra money?
• Your supervisor calls you into her office and shuts the door. There’s a tense, pregnant silence as she takes her place behind her desk. “As you know, we’ve had a tough year,” she begins. You shift nervously. So does she. “And we’ve reached a point at which we have to cut back and let some people go. Yours is one position we have to downsize. You’ll receive two weeks’ severance.”
One Thing Is Certain: Life Is Uncertain
Costly emergencies. Care for an aging parent. Loss of your job. No doubt you’ve encountered some of these financial storms already. Somewhere in your future, they’ll dump on you again. We all know we can’t keep life’s storm clouds from raining on us; they’re an inevitable, unavoidable part of walking this earth. If one thing is certain, it’s that life is uncertain. Each morning we rise from our beds not knowing what challenges will come our way. But we’ve been around the block enough to know that real life is not all pleasant breezes and blue skies. Skies darken. Lightning strikes.
And life’s storms often cost money. Sometimes big money.
Despite all of your hard work, current income does not always meet current expenses. Life’s little and not-so-little financial surprises just do not time themselves to fit neatly within your income streams or monthly cash flow. When you’re trying to stay solvent from month to month, working hard just to keep up with the ever-increasing cost of living, let alone to save for long-term needs such as your retirement years, those storms can wreak havoc on your best-laid plans.
Acknowledging the potential of life’s certain uncertainties underscores the importance of being better prepared financially so that we can weather those storms without getting buried in debt, depleting retirement savings, losing our homes, or having to mooch from our family and friends. It means buying a good umbrella before the deluge hits. Financial emergencies are never fun, but at least we can be better prepared so that we control the financial outcome instead of letting circumstance determine our destinies.
But alas, you do not live among the most prudent of savers. In the most prosperous country in the world, the average American household sets aside less than 4 percent of its gross income for long-term and short-term savings combined. As I write this, Americans collectively have spent more than they earn over the past six months, virtually relegating savings to an afterthought. The wise author of the ancient proverb must have foreseen our contemporary mind-set when he wrote: “The wise man saves for the future, but the foolish man spends whatever he gets. . . . A prudent man foresees the difficulties ahead and prepares for them; the simpleton goes blindly on and suffers the consequences (Proverbs 21:20; 22:3 TLB).
Foolish man. Simpleton. In today’s language, stupid. That ancient proverb holds true for us today: ’Tis a stupid mistake to spend everything we make and not set aside a reserve for the difficulties ahead.
It’s not that most of us don’t want to save for the future, or that we don’t realize the need to do so. Rather, we allow too many other things to wedge their ways topward on our priority lists.
It’s Parkinson’s Second Law, which we visited in Chapter 1: Expenditures rise to meet income. Individual expenditure not only rises to meet income, but tends to surpass it, and probably always will.
Take George, for example.
“There Just Isn’t Anything Left to Save!”
George contends that he makes just enough to get by—that after his regular monthly expenses, “There just isn’t anything left to save!” But a closer look at George’s expenses reveals that in reality he has all the money he needs to do what he wants to do.
Each weekday morning George stops by Starbucks for a large espresso coffee and a scone: $6 plus tip. Doesn’t seem like much until you add it up: $6 every workday totals $132+ each month. George also carries a cell phone with average charges of $58 per month; makes payments on a pleasure motorcycle at $196 per month; and leases a brand-new car at $269 per month. At home he has the latest high-tech digital connections for both his computer and his big-screen TV and subscribes to a premium TV channel, all totaling $86 per month. George also has five credit cards and carries balances on three of them with minimum monthly payments totaling $225 per month.
Yet poor George has trouble setting aside money in savings. Deep down,
You May Be Making Stupid Mistake #2 If . . .
• you find yourself thinking that, with all your monthly expenses, there just isn’t enough money left to save
• a family member has to undergo expensive tests or surgery and you can’t readily handle the deductible and copayment without debt
• your car suddenly goes plooey and you have to carry the $650 repair bill beyond the thirty-day grace period on your credit card
• you lose your job tomorrow and your present nonretirement savings will cover less than three months’ regular living expenses while you search for work
• in order to take a much-needed, well-deserved vacation, you have to borrow money or use credit cards to finance it
• you presently have no program in place that automatically shifts money from your paycheck or checking account to a savings plan
• an aging parent needs financial help and you don’t have the available cash to come through
he knows he should, but life’s just too expensive right now. Maybe after his next raise. Or maybe after he pays off his credit cards. Right now, he complains, he barely makes enough to get by, and there’s nothing left to save.
What’s wrong with this picture?
It’s easier to see the problem when you’re looking at someone else’s finances, isn’t it? By convincing himself that he “needs” all of the above in order to endure each day, George has made top priorities of what only a few years ago were considered luxuries—if they were considered at all. (Did you know what a latte was twenty years ago? How about a cell phone or high-speed Internet access?) By deeming such items necessities and regarding them as almost as crucial as housing, food, and clothing, George fritters away at least $966 each month—that’s $11,592 each year—on unnecessary “necessities” while complaining that “There just isn’t anything left to save.”
And what happens when a financial emergency comes along? Well, remember, George has those credit cards. He’ll whip out a piece of plastic to finance a car repair or a steep medical copayment, which only digs his hole deeper and postpones savings to an even later date.
A Small Priority Shift
Can we help poor George? Can we help him overcome Stupid Mistake #2 and begin setting aside part of his income so he can weather life’s fiscal storms and not have to mortgage the future to pay for the present?
You bet we can. And we’ll do it without taking away all of his fun, for after all, money is a tool to help us enjoy life. But do you agree that, by making some small shifts in his priorities, George could probably recoup at least one-half of his non-necessity spending? That would enable him to begin setting aside $483 each month in a money market fund—an “emergency reserve” that he could continue building until it reaches the equivalent of three or four months’ (truly necessary) living expenses. If that money market fund averages just 4 percent per year, George will build a reserve of more than $12,000 in just two years. In three years it’ll grow to $18,442. If he leaves this sum intact and continues to let it grow, it will serve as his “umbrella” for those inevitable rainy days in his future. The result: confidence that he can better handle life’s financial emergencies—with cash instead of deeper debt. Peace of mind. Freedom from all those monthly payments. More money to invest more wisely for the future.
Worth the discipline? You bet.
What successful saving comes down to, really, is the daily sense of urgency and priority you assign to it. If disciplined, aggressive saving has been a problem for you, try looking at it this way: If your employer were to suddenly inform you that he had to reduce your salary by $500 per month, you would hustle to find a way to make ends meet. You’d slash frivolities, reduce necessities, and look for sources of supplemental income. Somehow you would adjust your lifestyle in order to “find” the $500 each month you need to make it on your new salary.
Now approach your savings program with the same sense of urgency and priority. You need to steer serious money toward savings, and you can no longer afford to wait until Someday. You need to begin today to build a liquid, accessible contingency reserve that’ll be there for you when storm clouds burst.
But when your normal cost of living seems to consume every dollar between paydays, where do you find the money to save? If you find yourself thinking, I just don’t have enough money to save as I should for the future, don’t despair. You may have more money than you think.
Just as we did with George, step back for a moment and contemplate some of your regular expenditures. You just might be amazed at the money that’s there for the finding—hundreds, maybe even thousands of dollars each year—that you could easily reprioritize to a systematic savings program for your future. For starters, consider five strategies . . .
1. Adjust a Habit
Let’s face it: We all have at least one habit that consumes lots of money. A $4 gourmet coffee each weekday morning adds up to about $88 per month or $1056 per year. A daily $6 fast-food lunch totals $132 each month—$1,584 in a year.
One extra $25 restaurant visit per month totals $300 per year. Adding two $5 desserts to that tab consumes an additional $120 per year.
One additional movie for two each month, with two medium popcorns and two medium soft drinks, can run $26 or more, or $312+ per year.
As you consider the habits of your life, do you see some potential found money? For example, if you were to brown-bag your weekday lunches instead of fast-fooding them, you’d reduce your daily tab from $6 at the nearby BoogieBurger to, say, $1 for your own groceries. You’d “find” approximately $110 each month. That savings alone, redirected to a money market fund averaging just 4 percent, will grow to $7292 over five years. Invest it in a tax-deferred retirement savings program averaging a conservative 8 percent, and in fifteen years it will grow to $38,064.
Do the math on some of your other habits and you’ll be amazed at the found money that’s there for the saving—and its potential for growth over time.
2. A Penny Saved . . .
I know couples who, by starting early and being consistent, funded most of a child’s college education with the following strategy. Likewise, you can use it to help enhance your savings for your own long-term needs and dreams.
On almost any given day you come home from work or from a round of errands with loose change in your pocket. Say that on a typical evening you return home with three quarters, a dime, two nickels, and three pennies: 98 cents. Some days you’ll have more, some days less, so consider 98 cents an average day.
Place those coins in a jar each evening and watch what happens. At the end of a month your daily 98 cents will total $30 or so. Put each month’s savings aside in a money market fund averaging 4 percent and in five years it’ll grow to $1989. Invest it in a mutual fund averaging 8 percent, and over the next fifteen years your loose change will grow to $10,381.
And just for the fun of it, what happens if you add just one of the dollar bills in your wallet or purse each evening? In a month your small change is worth around $60. In a money market fund averaging 4 percent your monthly $60 will grow to $3978 in five years. Over fifteen years, invested to average just 8 percent, your found money can grow to $20,762. Small change, big potential!
3. Clean up That Mess
If you’re like most American families, you have an extra vehicle (or two) that isn’t really necessary but is draining cash for payments, registration, insurance, gas, oil, and repairs. How many hundreds or thousands could you save each year if you were to sell just one of those vehicles? It might mean sharing some rides, but a little planning, communication, and conversation among family members won’t hurt a bit.
What about rarely used motorcycles, bikes, RVs, boats, Jet Skis, skis, in-line skates, exercise equipment, tools, or books you’ll never read again? Perhaps you’ve hung on to an old TV set, a CD or tape player, or a CD or video collection. Survey your place for at least three items you could sell for a hundred dollars or more, then place a classified ad and post fliers on the bulletin boards at work. You also may discover that you’ve accumulated enough stuff to stage a profitable garage sale. Do this once each year, and instead of spending the found money, steer it toward either contingency or long-term savings. Just one $300 lump sum each year, invested at 8 percent over fifteen years, will compound to more than $8145.
4. Enjoy a “Hang around” Vacation
Instead of taking another costly resort vacation, rejuvenate at home this year. Don’t tell anyone your plans, turn your phones off, and laze around the house to your heart’s content. Sleep in, putter in the garden, paint a landscape, read a novel, take a hike. Play miniature golf. Rent a movie classic. If your vacation would have cost $2500 and you reprioritize that money to savings, your rainy-day fund will receive an immediate, significant boost. Put the $2500 to work in a mutual fund averaging 8 percent over fifteen years, and your found money will grow to $7930.
5. Save Hundreds on Insurance
With some adjustments to your insurance policies you may be able to save a few hundred to a few thousand dollars each year—without a meaningful decrease in the quality of your coverage. How?
Consider term life instead of whole life. In the vast majority of cases, you’ll receive far greater value for your dollar with a level-premium term-life–insurance policy—much higher coverage, much lower premium. If you feel you’ll always want to have some life insurance, then by all means keep whole life as part of your package. But carrying all the coverage you need is much easier on the pocketbook if you buy a level-premium term policy and invest the difference—with the goal of building sufficient assets to be self-insured by the end of the policy term.
Forget life insurance on your children. The chief purpose of life insurance is to replace essential income when a breadwinner dies. Does a child provide income essential to his or her family? Probably not. Therefore, it usually makes little sense to carry life insurance on a child.
Decline credit life and mortgage life insurance. Such specialty insurance is rarely a good value for the consumer, which is exactly why companies pitch it with gusto. You’ll save and simplify by accounting for these contingencies in the total face amount of your basic life policy.
Raise your deductibles. Increasing your auto and homeowners deductibles to $500 or $1,000 can cut your premiums by 20 percent.
Maximize discounts. Carry homeowners, auto, and personal-liability policies with the same insurer and receive a multiple-policy discount. Protect your home with deadbolt locks, fire extinguishers, and smoke detectors and receive an additional homeowners-policy discount. Ask about auto insurance discounts for being over fifty-five, having a clean driving record, and equipping your car with air bags, antilock brakes, or antitheft devices.
Let’s say you’re able to shave $500 a year from your insurance premiums. Redirect this found money to your contingency reserve for an immediate boost. Or put it to work each year at 8 percent, and over fifteen years, your newfound money will grow to $13,576.
Make Savings a Fixed Expense
The above are just some of dozens of areas where, like George, you may find money in your cash flow that you can reprioritize and redirect to savings. Indeed, you probably have more money than you think.
The next challenge is actually making the act of saving happen. Unfortunately, most individuals and couples tend to regard personal savings as an afterthought. We first pay out for all of our monthly expenses, including debt service, then see if there is anything left for savings. But the key to successful saving is to actually reverse this procedure and put Parkinson’s Second Law to work in our favor.
Since expenditures are bound to meet (or exceed) income, then the way to make sure we save each month is to make savings a fixed monthly expense instead of an afterthought. Instead of saving only when we “have something left to save,” we make savings a new high priority, right up there with mortgage payments and groceries. This strategy is called “pay yourself first,” and it’s the key to diligently setting funds aside to become better prepared for future emergencies, needs, and dreams. (It’s also the key to building a financially independent retirement, but we’ll focus on that in a later chapter. Today we’re talking specifically about being better prepared for the financial surprises that can set us back in the meantime.)
So get aggressive and elbow your way to the front of the line. From this day forward, you are your number one creditor. Personal savings is now one of your most important fixed expenses. From now on, you should steer a predetermined percent of each month’s income to savings before you pay any other bills.
I know what you’re thinking: Paying yourself first goes against human nature. When you have a finite sum of money and a seemingly infinite pile of bills and other spending opportunities, the natural inclination is to pay everyone else first and then see if some miraculous aberration leaves you a nickel or two to tuck away for later. But you only have to look at people like George to see the error of this line of thought: How much had he been able to save with the old end-of-the-line approach? Nada. For this reason it’s vital that, in addition to reprioritizing your spending habits and stepping to the front of the line, you also ensure the act of regular, disciplined savings by making the saving process automatic.
Put It in Automatic
Many employers offer a program whereby you can designate a specific amount of your gross income to be deducted from your paycheck and sent directly to a money-market fund on your behalf. Because you do not see the money or hold it in your greedy little hands, you won’t even miss it as it goes into your savings. Deposits happen like clockwork, and you’ll be amazed at how quickly they add up, assuming you don’t deplete your balance every time you have a craving for a piece of new stuff.
If your employer doesn’t offer direct deposits to savings, you can still save automatically by arranging an automatic draft from your personal checking account to a money market fund. You can direct the fund to draft biweekly or monthly, depending on which is more convenient for your cash flow. Your only obligation is to be sure you deduct the specified amount from your checking account ledger by the designated day of the draft.
Kathy and I were blessed to learn these principles during the early years of our marriage. We served in a worldwide ministry where the work was abundant but the pay was not, and, although we knew the value of disciplined savings, our savings habits were sporadic at best. It wasn’t until we learned about making savings a high-priority fixed expense that we began to grasp the incredible power of the pay-yourself-first principle.
At first we agreed to designate 5 percent of our after-tax income to savings. And at our income level, that was a “reach” for us. I admit that it took some adjusting. But after just a couple of months we realized that we didn’t miss the money that was automatically going to savings—our cash flow and budget had reconfigured around our new priority. As the balance in our money market fund grew, we were motivated to keep it going and growing. Soon the pay-yourself-first principle enabled us to purchase our first home. Over time we moved on to other endeavors and our income increased, so we increased the percent of income designated to automatic savings and investment. Like everyone else, we’ve endured a few financial storms along the way. But Kathy and I can attest to the fact that paying yourself first—automatically—has been the key to building and maintaining a rainy-day fund to help weather those storms with minimal damage.
So whether your employer deducts savings from your paycheck or your money market fund deducts it from your checking account, you can send a portion of your earnings to savings automatically—before you even have a chance to see it, hold it, or give in to temptation and spend it. Instead of paying everyone else first and ending up with only lint in your pockets, you can truly pay yourself first and build an accessible contingency reserve for the pesky or precarious emergencies in your future.
Aim to build and maintain a reserve equal to at least three months’ living expenses. If you work in an industry that tends to experience dramatic swings in employment, you may want to build a reserve that could keep you going at least five or six months.
Where to Save for Those Rainy Days
When a financial emergency comes along, you want to be able to access the needed funds quickly and conveniently. You don’t want to have to sell a long-term investment, such as stocks, that may happen to be in a downswing; nor do you want to use funds that would impose taxes and penalties for early withdrawal, as would be the case with a tax-deferred retirement savings plan.
For these reasons, most financial advisers suggest using a money market fund as an ideal vehicle for building and maintaining an accessible source of cash for life’s inevitable rainy days. It’s a type of mutual fund that invests conservatively in an array of short-term vehicles such as certificates of deposit, commercial paper, and U. S. government securities. The better ones will bring you higher returns than a bank savings account while maintaining your need for liquidity and preservation of principal. Unlike regular mutual funds, where your principal fluctuates according to market demand, a money market fund maintains the value of your original investment and pays monthly dividends on the earnings of its portfolio. It is not a guaranteed or insured savings vehicle, but its investments are typically so conservative and short-term that financial experts deem it just as safe, and probably safer, than an insured bank account. If you’re in a high tax bracket, you can choose a tax-free fund.
The money market fund you use will come with free check-writing privileges (usually for a minimum amount ranging from $100 to $500) and the option of making automatic deposits on a regular basis. It will require a minimum initial deposit of $500 to $1000 or more (sometimes waived if you sign for the automatic deposit) and minimum subsequent deposits of $50 or more. You won’t want to use this account for everyday check writing; maintain your local checking account for that. But your money market fund will serve you well as a convenient, disciplined vehicle for systematic savings.
Money market funds are typically part of a mutual fund family, adding extra convenience when you’re ready to shift some of your savings into higher-risk, higher-reward vehicles such as stock-and-bond mutual funds. Hundreds of mutual fund families clamor for your savings and investment dollars. Among the best are:
• The Vanguard Group (Prime Reserve Portfolio) 800-662-7447,
• American Century Investments (Prime Money Market) 800-345-2021 or 816-531-5575, and
• Fidelity Investments (Cash Reserves) 800-544-6666.
Customer service representatives at each family will be happy to answer your questions and send you a brochure and application form for the fund. The material will arrive in three to five days. While you wait, determine the amount you will commit to either biweekly or monthly automatic deposits. Try to begin with a minimum of 5 percent of your current take-home pay. If that’s too steep under your present circumstances, commit to something—$50 per month is better than $0 per month. Eventually you’ll be able to increase your automatic savings commitment to 7, 10, 12 percent or more of your after-tax income as you build a cash reserve equaling three to six months’ living expenses.
After you receive and read the material for the money market fund, fill out the application. You’ll be asked to choose between having monthly dividends mailed to you or reinvested in the fund: choose the reinvest option to help your savings compound faster. Mail the application with a check for your initial deposit. Beginning the following month, on the day(s) you have specified, your new money market fund will automatically draft the specified amount from your checking account. All you have to do is leave it alone and watch it grow. You may also want to speed up the growth of your contingency reserve by adding lump sums as they become available, or increasing the amount of the automatic draft to your fund as your income increases.
Your goal is to build, and then maintain, a balance equal to at least three months’ regular living expenses. You may want to maintain the equivalent of four, five, or six months’ living expenses; the amount is your call and depends on your situation and your comfort zones. The purpose of the rainy-day fund is to serve as an “umbrella” during the sudden downpours of life, to help shelter you and your loved ones from life’s urgent needs and expensive surprises so you won’t have to take on consumer debt, mortgage your home, or dissipate your retirement savings.
Don’t wait till it pours to realize you don’t have an umbrella. If you have not yet started a contingency reserve, I want to encourage you to call one of the 800 numbers listed above and get started this month. And if you do have a rainy-day fund but need to build the balance and maintain the balance at a more comfortable level, I hope the motivation and strategies in this chapter will help you do just that.
By making a small shift or two in your spending priorities and redirecting the found money to contingency savings, and by putting yourself at the front of the line by taking advantage of automatic savings programs with money market funds, you can enjoy the peace of mind that comes from knowing that you have a good chunk of cash ready when surprises come. A well-maintained rainy-day fund won’t necessarily keep the storms from coming, but it will sure help keep them from washing you away.