When The Atlantic’s May 2016 issue released The Secret Shame of Middle-Class Americans, it made rounds in the world of personal finance. Over the past few years, the US Federal Reserve Board released an annual study on the economic well-being of US households to take a pulse on Americans’ financial health and aptitude. A portion of the 2015 report documents the response to a hypothetical emergency expense of $400. Imagine a failed alternator, freak medical procedure, or laptop going up in smoke. When faced with this unexpected liability, 47% of respondents said they could not pay the expense with cash (or a functional equivalent) or would borrow/sell something to do so. Even more shockingly, 19% of respondents with a household income of $100,000+ fell into this category–too strapped to cover this expense with cash or any form of savings.
After hearing this news, I got to thinking more about the power of small savings. In crafting an essential lifestyle, we need to evaluate how we use our resources: time, money, and energy. While financial mastery is by no means required, understanding personal finance as a tool and knowing how to leverage it absolutely is. Imagine both sides of the aforementioned prompt: those prepared and those not. Living in a constant state of fiscal anxiety would be detrimental to one’s overall happiness. On the other hand, decoupling yourself from the paycheck-to-paycheck lifestyle brings about a priceless peace of mind. A small financial cushion can have a large impact on your security and financial outlook. This is why I encourage everyone to grow their own stash of mental freedom also known as an emergency fund.
My Journey to Savings
Shortly after beginning my first full-time job, I was faced with a debt many young Americans are all-too familiar with: student loans. And because this is such a common scenario, I’m pleased to share my experience of building my fund and paying down debt in tandem.
While the exact amount of cash for an emergency fund will be hotly debated, a reasonable assessment takes into account the following factors: current expenses, job stability, dependents, risk tolerance, and your marketability. In many financial circles, a fund of three to six months of expenses is recommended. Yet as you can imagine, each person’s tolerance will vary. While a single, highly desirable employee in a low-cost location may save two to three months, a self-employed head of household with three children may see more value in saving six months of expenses.
When I began saving, my expenses were somewhere around $2,000/month. While my job was stable, I estimate conservatively. Hence, I landed somewhere between three to six months of expenses. Thankfully, you get to count any cash you already have saved up–this means you’re part of the way there! If this sounds a little daunting, don’t fret. Becoming a financial guru is not the goal of this exercise, the hope is improving your financial outlook and employing the power of small victories. This progress will bring a spectrum of relief–with each paycheck, more and more of your freedom will be returned.
If calculating a multiple of your monthly expenses seems a little much, perhaps reviewing past challenges will help orient your savings goal. My largest unexpected expense was replacing the engine in my 2001 Honda Accord. It set me back over $2,000 (perhaps a story for another time…), and while quite unfortunate, the next largest unexpected liability was no more than a third of that. Therefore, even a few thousand dollars would achieve some financial sanity. What was your largest expense? Can you use that as another data point in constructing your emergency fund?
Since all of my loans were distributed by the federal government, I took full advantage of the six-month grace period after graduation. Although they accrued interest during my first few months of my employment, I delayed payments and dedicated resources elsewhere. Taking advantage of that period, I contributed a portion of each paycheck to my life savings with the goal of reaching my magic number. Once there, I felt very comfortable in redirecting all additional monthly savings to my student loans. In adding a few thousand dollars to my overall net worth, I had achieved a newfound piece of mind. I no longer had to worry about facing an unexpected expense. Internalizing the importance of a financial cushion taught me a few valuable principles.
First, I jettisoned myself from living paycheck-to-paycheck. In order to create my little freedom fund, I had to live below my income. There was no other way. Designing an essential life is not about balancing your income and expenses–it’s about living below your means and making it count. Even if you save $100 per month, you will join the 53% of Americans capable of covering a $400 expense in no time.
Second, I now understand the power of small cash reserves. While a few hundred dollars per month may seem trivial, the couple thousand dollars amassed by the end of year one will speak volumes. The real beauty lies in how the tangible translates to the emotional. Remember how buying freedom is a gradient? Over the course of your savings, you will grow more excited and motivated by your fund. The financial anxiety that keeps so many up at night will subside. The self-control you exhibit during this exercise will serve you well in the future.
Finally, it laid the groundwork for developing more advanced financial intelligence. Not only do I have a sense for how it feels to possess a small reserve, but I also know what it takes to get there. The journey is an equally important part of this process, and lessons learned during this growth can translate to higher-level savings goals. For example, saving tens of thousands of dollars to purchase a new car no longer appeals to you once you know what it takes to redesign your lifestyle and save that amount of cash. Understanding that helped me save up money to eventually terminate my employment.
Let’s Build a Safety Net
Living an essential life generates the opportunity to spend time on what matters most. Even if you begin saving $100 a month, you are choosing to prioritize your relationship with your finances and ultimately buying back freedom. There is no reason for you or half of America’s population to live in such desperation. As you work towards becoming more intentional with your money, why not create a genuine sense of security and flexibility? In following through on your goal, you’ll experience the power of small victories, learn to live below your means, and most definitely set your sights on future financial success. I urge you to spend a moment reflecting on how an emergency fund would provide you with this and more.