P Stands for Plan
SIMPLE Personal Finance Series
P Stands for PlanNing to be financially stable and secure
Society tends to celebrate spontaneity. It is an expression of life, energy and free expression. Spontaneity can be refreshing and enlivening. Dealing with spontaneous, unexpected financial challenges, on the other hand, is rarely a pleasurable experience. In fact, dealing with unexpected expenses is one of the main reasons households get into debt that becomes so overwhelming that it leads to bankruptcy.
Planning for both expected and unexpected expenses involves these steps:
Identify your savings needs for expected future expenses
Identify your savings needs for unexpected future expenses
Manage your expected and unexpected savings accounts
The amount is less important than commitment
By far, job loss and income reduction are the common causes of financial struggles that lead to bankruptcy. Other major unexpected financial hardships come in the form of medical emergencies, divorce expenses and the loss of an income-earning spouse.
Is it possible to eliminate these financial risks from your household? No. Risks will always exist. Much of life, try as you might, is beyond your control. Still, you will never regret putting together and putting into action a plan to deal with both expected and unexpected future events.
If there were a fire in your office building, you had better hope you know the exit plan. When traveling by plane, you may not listen as intently as you should to the flight attendants during their presentation of an emergency plan, but you are likely grateful the airlines have some sort of contingencies for emergencies. Follow their example and put together your own emergency financial plan.
P Stands for Plan. Specifically, P stands for planning for expected and the unexpected future expenses.
Identify Your Savings Needs for Expected Future Expenses
You likely already understand the importance of savings for unexpected events such as medical emergencies and vehicle repairs. However, consider the critical value of saving for expected events in the future. Such savings involves amounts of money you must have for a future expense or purchase that you cannot come up with through a single paycheck.
For example, if you are planning to go on vacation next summer, you will likely require more travel money than you can come up with from a single paycheck. Consequently, preparing for a vacation is an expected future savings need. From each paycheck between now and then, you can figure out how much you will need to set aside in a savings account so you will be financially prepared for your vacation. Other examples of expected future savings needs include appliance and furniture repair and replacement (no refrigerator lasts forever), birthday gifts, Christmas gift giving, back-to-school shopping and vehicle replacement (no car or truck lasts forever either).
Since the average refrigerator has a 15-year life expectancy, figure out how many years your refrigerator has left and start saving an appropriate amount to have ready at its fifteenth birthday, just in case. Likewise, if you have a car payment, once you have paid off your vehicle, continue to make those same payments, but instead of sending them to the lender, add them to a savings account you call your “Next Vehicle” account. After four or five years, you will have close to enough to purchase your next vehicle when necessary.
Identify Your Savings Needs for Unexpected Future Expenses
What about unexpected savings needs? How do you prepare for them, since they are impossible to predict? Some seem random (accidents, injuries, job loss) while others are inevitable (vehicle breakdowns, home repairs, back-to-school supplies and clothing, appliance and furniture replacement, etc.). The answer is simple: Save. From each paycheck, place 10% to 15% into a savings account in order to build a reserve fund for when you need it.
How much should you have for the random future expenses? Many experts suggest three months’ worth of income. Others recommend six months’ worth. There is no single right answer for everyone. Here are some good steps to determine your personal guidelines:
Determine how many months it might take to find your next job if you lost your current income. One rule of thumb is that for every $10,000 you earn a year, it will take you a month to find your next job. During recessions, you may have to double that rule. Additionally, some types of jobs are much easier to find than others are.
Next, figure out how much money you would need to pay for your monthly housing needs (rent or mortgage plus utilities), groceries, transportation and communications (phone and Internet).
Multiply Step 1 by Step 2. This is a good target for your emergency savings funds.
Manage Your Expected and Unexpected Savings Accounts
Too many households have either no savings account or a single savings account. If you have one, that is a great start. However, if you were to contribute gift giving money, vacation savings, and savings for emergencies into the same account, how will you differentiate between how much you have saved for each future need after just a few months?
Instead, consider setting up a separate savings account for each goal: one for emergencies, one for vacations and travel, one for holiday and gift giving, one for vehicle repairs and replacement, one for appliance and furniture repair and replacement, and one for household and yard repair and improvement. Your bank or credit union should not charge any fees for these additional savings accounts.
Next, automate transfers from your checking to these savings accounts to happen a day or two after each payday. Even better, check with your employer to see if you are able to set up an additional direct deposit into your savings accounts.
A Commitment Is More Important than an Amount
Opening multiple savings accounts might seem overwhelming to some, but consider the typical recommendation by “experts” to have 3- to 6-months’ worth of living expenses saved up for emergencies. For the 60% of American households living paycheck-to-paycheck, even one month seems impossible, let alone three to six.
For now, do not start with an amount in mind but with a commitment. If you have struggled to build an emergency fund in the past, then commit to save just a few dollars from EVERY source of income you have. This includes salaries, extra work, birthday or Christmas gifts, and unexpected refunds. Whether it is $1 or $10 or $100 to contribute to your savings, it is critical to start now. After all, a journey of a thousand miles begins with a single step. A single dollar can be the start of something monumental in your personal finances. If that seems too easy, start with 1% of your income. After a couple months, bump that up to 2%. Then, 3%, and so forth, until you are at 10% to 15% of your total household income.
Such recommendations may not ideally fit every household budget and circumstances. If you do not think they will work for you, then make some other plan, but have some sort of a plan. Not creating your own plan does not mean you do not have a plan. If you fail to plan for your financial future, your plan is to remain financially unstable and insecure indefinitely.
Make a plan, or your plan is to fail.
P Stands for Plan. You have one, whether you like it or not. Make sure it is a plan you can live with.