Managing Uncertainty
Recent stock market turbulence is a pointed reminder of why it is important to save enough to ride out investment storms
When the Dow Jones industrial average tumbles more than 1,000 points in one day, as it did in early August, people close to retirement may panic.
In a different scenario, your workplace decides to slash its workforce by 30% or your employer reorganizes, and eliminates your position.
Life is fraught with uncertainty.
By definition, "it's hard to gauge when an unexpected event will occur and what form it will take," said Catherine Collinson, CEO and president of the Transamerica Institute, a nonprofit think tank that researches retirement security. "We have to be prepared for them."
Stocks Can Fall, so Prepare
If you have an adequate emergency fund or rainy-day savings account, you will be able to withstand all but the worst financial setbacks. If you lose your job, such reserves gives you the ability to cover living expenses until you get back on your feet.
"It's hard to gauge when an unexpected event will occur and what form it will take."
"Cash is king," Collinson said. Having six to 12 months' worth of expenses in a federally insured savings account means that "no matter what is happening with the stock market, there is cash to pay bills."
Some data highlights just how few Americans have stashed away enough cash for rainy days and emergencies. According to Bankrate's 2024 Annual Emergency Savings Report most U.S. adults have not saved enough to pay for a surprise $1,000 expense. Only 44% would be able to do so.
Whether Americans have saved for emergencies varies by age. According to the report, approximately a third (31%) of people aged 44 to 59 have no emergency savings. Among people aged 60 to 78, 16% have no emergency savings.
To Feel Safe, Save
Research shows that having two different reserves — a rainy-day fund and an emergency fund — typically produces a better outcome. Both are vital to financial security. An emergency fund is usually larger, from $10,000 to $50,000 or more, in case of a financial shock such as losing a job. Rainy-day funds are smaller, up to $2,500 or so, enough to replace a refrigerator or other appliance.
Brigitte Madrian, dean of the Marriott School of Business at Brigham Young University, has said that having several savings accounts — each for a specific goal — encourages financial discipline by helping savers to visualize what they give up by using savings for something other than its intended purpose.
All of this may seem difficult if not impossible for people living paycheck to paycheck, and there are a lot of them. July data from Bankrate.com, a personal finance website, found that more than 1 in 3 workers (34%) said they live this way.
Some companies have in-house savings programs that help employees with automatic deductions from their paycheck into a savings account.
Why Saving Makes Sense
Among the best reasons to build emergency and rainy-day funds are to:
- Avoid credit card debt that you are unable to pay off in full each month.
- Prevent the need to take early withdrawals from retirement savings, such as 401(k) plans and Individual Retirement Accounts (IRAs).
- Allow yourself time to "complete a successful job search," said certified financial planner Lauren Zangardi Haynes, owner of Spark Financial Advisors in Richmond, Virginia.
Those in their 50s are typically in their "peak-earning years," she said.
"If you lose your job, it's harder to find a position at the same level as your previous position," she added. "Think of how long it will take to get a new job. It's a real risk for people in their 50s, even if they are really successful."
Be Disciplined ... and Patient
Building the funds is not an overnight process. It requires developing good spending and saving habits. "You can split your paycheck between your checking and savings accounts," said Zangardi Haynes. If your employer automatically diverts part of your pay to your savings account, you are less tempted to spend.
To get your savings account off to a running start, deposit your entire tax refund, if you receive one, in the account. Another way to turbocharge a savings account is to regularly increase the amount automatically diverted from your paycheck into savings. You also can occasionally look at which banks offer the best return on their high-yield savings accounts and move your money if the difference is great enough. "It has to be systematic," Ted Rossman, senior industry analyst at Bankrate.com, said.
How Much Is Enough?
Once you establish the funds in high-yield savings accounts, look to earn a bigger return by investing in a certificate of deposit or a so-called ladder of CDs — certificates mature on different dates to avoid having to reinvest all of your savings in a temporary decline in interest rates.
"It could be that you start with $50 per paycheck and gradually built it up. A long journey starts with a single step."
CDs are less liquid than savings accounts, but once you've established the basic funds and have enough in each, CDs are a next step.
How much is enough depends on your situation. A business owner with monthly overhead expenses to meet might need more than a salaried employee. If you are close to retirement, creating a larger cushion of one-to-two years of expenses can help you avoid sleepless nights.
This is "sleep-at-night kind of money," Rossman said.
Paying yourself first is an ideal way to stockpile cash. "If you try to save what's left (at the end of the month) there may not be any left," he said. "It's important to carve that money right off the top."
Spend Less to Save More
To ensure you will be able to save have enough to cover your essential expenses, consider how you can trim your spending. Scrutinize your credit cards or checking account statements to assess exactly how you are spending your money. Which expenditures can you skip next month? Subscriptions you don't want or need? Streaming? Impulse purchases?
Larger expenses such as a mortgage or rent payment or a vehicle payment can be harder to shrink so weigh whether or not to buy or lease a new car. The average monthly payment for new vehicles hit $735 in the first quarter of 2024, compared with $523 for a used one, according to Experian, a data analytics and consumer credit reporting company.
The best way to build rainy-day and emergency funds is to accept that you may have to start small. "It could be that you start with $50 per paycheck and gradually built it up," Rossman said. "A long journey starts with a single step."
