How Much In Liquid Savings Should You Have?
The harsh economic downturn of the past several years has shown us all the importance of a strong liquid savings account. Most people realize that they need some savings to keep them afloat if they ever need to go several months without a job, but exactly how much should we be saving? Depending on the financial expert you listen to, you may get wildly divergent responses ranging from a few months living expenses to an entire year’s worth. The truth is, there is no one answer that works for everyone. Your savings goals depend entirely on your unique financial situation, and the following tips should help you to decide on a plan that makes sense for you.
Calculate Your Total Monthly Bills
The first considerations you must make when planning out your savings are your monthly bills. No matter how serious your future financial emergency might be, you can bet that your creditors will not stop sending your bills, and your landlord will not refrain from knocking on your door while you work some new plans out. The bottom line is that your savings should be designed to keep you squarely focused on securing employment should you ever need it, rather than stressing out over impending eviction or vehicle repossession.
Begin by writing down every one of your monthly bills, starting with the most serious. Rent or mortgage payments might be first on this list, followed by utilities, car payments, all types of insurance, credit card debt, etc – all the way down to the lesser-crucial ones, such as Internet and television. Add all of these bills up to determine the minimum total you owe in bills for an average month.
Calculate Your Total Monthly Expenses
Monthly expenses are the essential things you choose to buy every month. Think about your food budget, pet care supplies (if you have one), gas, prescription medicine – anything you need to buy on a monthly basis should be counted as an expense of living. As a rule, it is generally better to over-estimate your monthly expenses, so that you aren’t forced to live on a razor thin budget should you ever need to survive on savings alone. Add this amount to your bill total and this is one month’s total cost of living for you.
Don’t make the mistake of confusing these with monthly bills, as there are important differences between the two. Bills are unchanging and nonnegotiable, meaning that every month you should owe more or less the exact same amount in to your bills. This is not so for your expenses. In a time of financial trouble, you could choose to save money by buying generic label food, but you cannot choose to pay less than the minimum on your mortgage without dangerous consequences.
Lifestyle Luxuries Are a Matter Of Personal Choice
What you decide to consider an essential monthly expense will greatly affect your target savings amount. Some people decide that all they need to live are the bare essentials, while others choose to include non-critical luxuries if they can afford to save for them. As an example, you might currently go to the movies twice a week, but if you find yourself in a situation where you must live on savings alone, will you choose to continue this behavior?
If so, your monthly expenses need to be increased by about $80.00 – $100.00 to allow for this luxury. The same decisions need to be made for eating out, pleasure shopping, and the like. Personal finance blog FrugalMom even advocates canceling your cable service if you lose your job. In general, the purpose of your savings nest egg is to keep you afloat for as long as possible while you secure new employment, not to allow for endless indulgence during financial hardship, so discern carefully.
Gauge Your Job Security
Now that you have your total monthly cost of living, you need to determine how many months you should save for. The truth is, there is no one right amount for everyone – it varies depending on your employment stability. Consider how the economy has been treating your career, and whether other people you know in the same industry have been laid off in recent years. Check out the annual stockholder’s report for your employer for information on how well the company is faring financially.
Those who feel they are at high risk for losing their employment, or work as independent contractors/consultants and only get paid when they acquire clients, should be saving as much as possible. Financial advisor Suze Orman recommends aiming for a reserve of 8 months for these people. Put another way, author and personal finance expert Bert Whitehead believes that “If you’re in danger of losing your job, you should have 40% of your annual income in savings.” Those with solid job security can choose to keep less in reserves if they wish.
Consider Your Income Replacement Options
The size of your liquid savings should be based on how difficult a time you would have replacing your current job. Those with highly-specific, focused careers (such as pharmaceutical chemists, or marine biologists) might have a hard time leaving their office and finding a similar gig across the street. These people need to be saving more, because gaining new employment might drag on for months and could even require moving to another area.
Conversely, those with a broader skill-set (such as software engineering or management) might not have as tough of a time securing a new job. These folks might choose to save a bit less for this reason.
Develop Your Savings Time Line
Once you have calculated the total sum of money you need to save in liquid assets, the next step is to develop a savings time line. The time line should illustrate how much you plan to save each month, and how long it will take you to reach your goal. The easiest way to do this is to deduct your total monthly cost of living plus investment contributions from your monthly income. The remainder is known as discretionary income (because it can be spent at your discretion) and can be saved for your target nest egg.
About the Author: Whitney Freestone is a freelance writer. Freestone is an experienced business and financial writer with areas of focus on bill consolidation loans as well as how to find a refinance car loan.