Wednesday, June 24, 2015

Cash on Hand

The latest numbers are out from Bankrate’s annual emergency savings survey. 29% of Americans have no emergency savings. They are literally living paycheck to paycheck. An additional 21% have some savings, but not enough to cover 3 months of normal living expenses. That means that about ½ of American households are financial disasters waiting to happen.

Only 22% of American household have enough savings to cover six months of living expenses.

The obvious question: (Quoted from the original Bankrate article.)

“Not surprisingly, income level is a great predictor of emergency savings. Fifty-three percent of those making less than $30,000 a year had no emergency savings. That's nearly twice as much as the $30,000-$49,999 group; more than three times as much as the $50,000-$74,999 group; and more than four times as much as the $75,000-plus group.”

Interestingly only 46% of households with an income of $75,000 a year OR HIGHER have the full six month emergency fund normally recommended by most financial advisors.

People between the ages of 30 and 49 are the age group most likely to have no emergency fund. Evidently, people under 30 years of age have been sufficiently frightened by the last 7 years to understand the value of an emergency fund. People over 50 are expected to have money in the bank. After all they have been employed for several decades. The middle group are the folks trying to maintain a middle class lifestyle that includes a house, family vehicles, child care, and keeping up with the Jones. That isn’t so easy to do in this day and time. They are living at the edge.

Authors have various opinions on the emergency fund. Dave Ramsey, for example, believes that anything under $1,000 cash on hand is an emergency. I agree. Twice during the early years of our marriage our liquid net worth dropped below the $1,000 threshold. In both cases I considered it an emergency that merited immediate attention. Those were mid 1970s dollars worth about $4.42 in 2015 dollars. I would think that anyone with less than $3,000 in readily available cash is asking for trouble. A rebuilt 2002 Honda transmission runs in the $500-$700 range. That does not include the labor it takes to pull the old one out and install the replacement.

An article from Business Insider by Libby Kane provides some common sense analysis of some conflicting thresholds.

She considers three months expense money on hand the dead minimum for healthy adults with no dependents. Three months is also the bottom of the 3 to 6 month acceptable range for Dave Ramsey’s “baby step 3.” The job market is finally improving. Household incomes are starting to creep upwards. Even though it isn’t 2009, could you be certain that if you lose your job you could find another job in less than three months?

Six months cash reserves in a federally insured savings or money market fund is the almost universally accepted number for a fully funded emergency account. This number goes back at least to the late 1970s when I first heard it on Bruce William’s talk radio show. Libby Kane believes a minimum of six months is particularly important for dual income households, families with dependents, or those living on commissions.

About five years ago Suze Orman decided to shake things up a bit by changing her recommendation from six months to eight months in emergency savings. Although this number is not widely accepted, the unemployed and underemployed who suffered through the Great Recession most likely would agree with the higher number. Libby Kane believes eight months would be appropriate for older folks or families with health problems. She also added retirees to this list. Depending on your retirement income situation, if you have less than many years’ worth of cash or near cash assets you better put off retirement for a few more years, but that is the subject for another time.

I haven’t changed my mind on this one for somewhere over 35 years. Number 7 on my list of basic financial rules is, “Start a “rainy day” fund in a bank or a money market fund. The goal here is six months cash reserve (six months take home, both salaries). It will take some time to reach this goal. Don’t beat yourselves up about this but keep putting a little something aside every month.”

I can’t remember when we actually built up a six month reserve, but I would guess it took us about 15 years.

Always pay yourself first. This is another one of those almost universally accepted financial rules. Before you start to plan your expenses, peel off 10% of your take home pay--right off the top--and put it in savings. If you make savings your first priority consistently over time the money will be there when you need it. If you can automate this process so that you never touch the money by using auto-debit to a separate account at your bank or credit union, so much the better. Finally, as you construct your monthly budget be sure to put something in the envelope marked contingencies. Dave Ramsey calls this the “blow” envelope because it is a certainty that some months will blow your budget right out of the water.

This is important. An emergency fund can keep you from using a high interest credit card to pay for something like a replacement washing machine or new tires for your car. Even $1,000 can save a family from payday lenders and other parasites. If you don’t have an emergency fund, start one today. Throw money in a jar. Hold a yard sale. Take a second, part time job for a few months. Pay yourself first. You won’t regret it.

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