{"id":52337,"date":"2021-10-19T07:16:00","date_gmt":"2021-10-19T11:16:00","guid":{"rendered":"https:\/\/www.shortform.com\/blog\/?p=52337"},"modified":"2021-10-26T09:41:07","modified_gmt":"2021-10-26T13:41:07","slug":"financial-safety-net","status":"publish","type":"post","link":"https:\/\/www.shortform.com\/blog\/financial-safety-net\/","title":{"rendered":"How and Why to Build a Financial Safety Net"},"content":{"rendered":"\n

Why is it important to have a financial safety net? How many months’ worth of living expenses should your safety net cover?<\/p>\n\n\n\n

No matter how much money you earn, it’s important to have a financial safety net\u2014a savings account with money you can use for emergencies\u2014to prepare for worst-case scenarios. To start building your safety net, figure out how much you need to save to cover your living expenses so that you can decide how much money to set aside each month.<\/p>\n\n\n\n

In this article, we\u2019ll explore how to automate contributions toward your safety net to ensure that you\u2019re prepared for worst-case scenarios.<\/p>\n\n\n\n\n\n\n\n

Why You Need a Safety Net<\/strong><\/h2>\n\n\n\n

There are two reasons to have a financial safety net. The first is to make sure you have a fund to see you through hard times. Bach states that the average American has less than three months\u2019 worth of expenses saved\u2014these people are financially unprepared for the bad, unexpected things that could happen such as if they have to isolate at home and quit work due to a pandemic.<\/p>\n\n\n\n

The second reason to build a safety net is to improve the quality of your life here and now. Bach argues that with extra money in the bank, you give yourself space to breathe and decide how you actually want to spend your time. For example, you\u2019re less likely to put up with a job that doesn\u2019t suit you if you have enough money to support yourself while you look for a more satisfying job.<\/p>\n\n\n\n

A recent study confirms Bach\u2019s belief that saving money improves lives<\/a>. The research revealed that people who save money tend to enjoy more happiness and satisfaction than those who don\u2019t save. This is because saving money increases your peace of mind and decreases your psychological distress\u2014with extra money, you feel more prepared to handle uncomfortable situations.<\/p>\n\n\n\n

Bach outlines two steps to create your financial safety net: assess how prepared you are and grow your savings<\/a>. <\/p>\n\n\n\n

1. Assess How Prepared You Are<\/strong><\/h3>\n\n\n\n

Bach explains that financially secure<\/a> people aim to save at least 3 to 24 months\u2019 worth of savings. To figure how long you could survive on your savings without additional income, answer the following questions:<\/p>\n\n\n\n

  1. What are your current monthly expenses? Include your essential living expenses (rent or mortgage, insurance, food, and so on).<\/li>
  2. How much money do you have saved?<\/li>
  3. If you had to rely solely on your savings, how many months\u2019 worth of savings would you have? (Divide your answer to question 2 by your answer to question 1.)<\/li><\/ol>\n\n\n\n

    Once you\u2019ve answered these questions, you\u2019ll have a better idea of how financially secure you are and how much more you\u2019d like to save to feel like you\u2019re on solid ground.<\/p>\n\n\n\n

    (Shortform note: Bach doesn\u2019t explain how to accommodate irregular salaries\u2014income that varies from month to month\u2014when safety net building. If your income is irregular, first follow the steps above to figure out how long your savings will last if you lose your income. Next, consider creating a buffer to protect your safety net. Sethi suggests that, in addition to your savings accounts<\/em>, you also set aside three to six months\u2019 worth of living expenses to cover you during the months when your income doesn\u2019t cover all of your expenses. This way, you can simulate a stable income<\/a> and you won\u2019t have to dip into your savings accounts to cover your expenses during low-income months.)<\/p>\n\n\n\n

    2. Grow Your Savings<\/strong><\/h3>\n\n\n\n

    Bach recommends keeping your emergency savings<\/a> separate from your checking account so that you\u2019re not tempted to spend the money. Further, he advises that you invest the money in high-yield savings accounts so that it can earn interest and grow. While interest rates have dropped over the past twenty or so years (12% in 1990 to 1% in 2016), your money will still grow more than if it sits in a normal checking account.<\/p>\n\n\n\n

    (Shortform note: Bach\u2019s process focuses on creating a single savings account and doesn\u2019t accommodate the large expenses you\u2019ll have outside of unexpected emergencies. In contrast, in The Barefoot Investor<\/em><\/a>, Pape recommends that you allocate a percentage of your money to an additional \u201chappy\u201d savings account<\/strong>\u2014an account used for large expenses that you want to save up for such as a holiday or a car\u2014and a \u201cgrow\u201d savings account<\/strong>\u2014an account for long-term investments and savings goals. This way, you don\u2019t need to dip into your long-term savings accounts to fund your large expenses.)<\/p>\n\n\n\n

    How to Choose the Right High-Yield Savings Account<\/strong><\/h4>\n\n\n\n

    Bach suggests that you research what interest rates and fees different savings accounts offer and check the following points before you decide on the account best suited to your needs:<\/p>\n\n\n\n