Survey after survey shows that Americans do not save enough money for emergencies or for retirement. The Wall Street Journal reports that Americans are saving more than in previous years. However, another survey, presented in an article by The Motley Fool, shows that Millennials (those under 35 years old) have a negative savings rate, but the average savings rate tends to increase with age. NeighborWorks America found that a third of American adults have no emergency savings (USA Today).
So, how much money should you be saving? Let’s start by discussing Emergency Funds.
You should have enough money in an emergency fund to pay 3-6 months of expenses. Notice I said ‘expenses’ not income. Keep reading… Some experts suggest you should have even more than this because of the current length of average unemployment. Regardless, 3-6 months is a good amount to aim for. If saving more makes you feel more safe and secure, then go for it but you really shouldn’t need more than 9-12 months.
An emergency fund is also known as a rainy-day fund. It’s there to cover you when the storms of life hit. According to LearnVest, “an emergency fund should really be used only in the five following situations:
- You’ve lost your job, and need to continue paying rent, bills and other living expenses
- You have a medical or dental emergency
- Your car breaks down, and is your primary form of transportation
- You have emergency home expenses—i.e., your A/C breaks down in 100+ F weather, your roof is leaking, your basement is flooded, your toilet is overflowing, etc.
- You have bereavement-related expenses, like travel costs for a family funeral”
In a four month period several years ago our family faced unexpected job loss with no severance, hospitalization of our son for 11 days, and our daughter’s wedding. Because we had an emergency fund in place, plus money in our HSA to pay the high medical deductible, we were able to face all of these without having to go into debt to cover any of these expenses. Not surprisingly, the wedding was not extravagant. It didn’t have to be. But, it was lovely! Moral: Having an emergency fund is essential to surviving the financial stresses life throws your way.
Having an emergency fund is essential
So where to begin? First of all, you need to make sure the money is available when you need it. Find a place to save it that pays the best interest possible, which isn’t much right now, but it’s better than needing the money and not having immediate access to it. For ideas of where to keep it, check out our article here.
You need to start with a goal of saving $1,000 to $1,500 dollars as fast as you can. Cut back on eating out, or buying clothes for now (you have enough in your closet to get you by!), basically cut back in other areas to get that money saved quickly. Our article, Five Simple Ways to Spend Less on Groceries, gives some good ideas on one area you can save money.
Next, you need to pay off all your debt before you continue saving. Do the same method of cutting back and pay it off as quickly as you can. The long-term burden it takes off your shoulders is worth any short-term pain of missing out on a restaurant meal that you may enjoy while you are eating it, but by the next day does nothing for you and has no long-term benefit.
Now, go back to putting money in your emergency fund until it is fully funded (3 to 6 months’ expenses). The peace of mind of having a fully funded emergency fund is worth every sacrifice.
After your emergency fund is in place, it’s time to make a plan for saving money for retirement. “Social Security is my retirement money” is not a plan. At all. Especially if you want to do more with your retirement than sit and watch TV.
Some people think you should be saving money for college for your kids before saving for retirement. I like what I’ve heard Dave Ramsey say (and I’m paraphrasing): “Your kids can borrow money for college, but you can’t borrow money for retirement.” (Disclaimer: Dave Ramsey does not advise borrowing money for college. This comment was thrown out there to show that it’s available as an option for college, but is not an option for retirement. Someone told me that Dave Ramsey would never say such a thing, but I clearly remember hearing him say it years ago.)
To save money for retirement your goal should be to save 15-20% of your gross income. You start by participating in your employers 401(k) plan and putting in the maximum percentage required to get the company match. Then, max out a Roth IRA. Next, go back to putting the rest into the 401(k) plan.
But how do you do this if you currently are saving nothing for retirement? You take it a percentage at a time. Start by putting 1% of your income in the 401(k). Next quarter, up it to 2%. The quarter after that add one more so it’s 3%. Then 4% three months later. By the end of the year you are ready to save 5%, where before you were saving nothing. If you already were saving 5%, now you are saving 10%. You might even decide that the 1% increases were barely felt and you can do 2% a quarter. Whatever percentage you are currently saving, increase it until you are saving what you need to save for retirement.
Adjusting your spending a percentage at a time is easier than suddenly having 15-20% less to spend. You won’t feel it as much. But it will make you smile as you see the balances in your 401(k) and Roth IRA grow. Especially when you see how much free money your employer adds to the 401(k). Much better return than the stock market!
If you currently are saving 15%, but want to gradually increase it, then up the percentage by 1% for the whole year, instead of each quarter. Increase per quarter if your savings percentage is low or none. Increase per year if your savings is already pretty high, but needs to be higher.
However you do it, make a plan to increase your savings. Fully fund your emergency savings. Increase the amount you save for retirement. When you learn to live on less than you earn, the peace of mind that comes will let you begin to truly live.
Updated to add the disclaimer about the Dave Ramsey comment.