Build a Rainy Day Fund to Cushion Adversity
Do you have a big enough financial cushion to withstand the recession that many economists say is coming or is already here? If you lost your job or suffered other financial setbacks, could you make it through the transition?
If the answer is no, or you aren’t sure, start now to build up your financial reserves. You don’t want to be caught without adequate rainy day funds or with retirement savings that you could lose if your employer goes bankrupt.
Building a financial cushion “will put you well on your way to financial security,” says Jonathan D. Pond, president of Financial Planning Information, a Watertown, Mass., publisher of financial planning information. “People who are well prepared for a recession have been doing this all along.”
Financial advisers say you should have accessible savings equaling three months of your gross income. That includes any assets that are readily converted into cash, such as money in savings accounts and mutual funds or widely traded stocks and bonds.
If you don’t have this three-month cushion, get serious about building up savings. Set a goal of saving at least 10% of your income.
“It’s inexcusable not to save 10% of your gross income, and most people should aspire to 15% or 20%,” Pond says.
There are several ways to save automatically. Enroll in a payroll savings plan at work that will put your money in U.S. savings bonds or in a credit union savings account. Get your bank to pull money automatically from your checking account into your savings account.
Get a mutual fund that will automatically draw a certain amount each month from your checking account. Change your withholding to reduce the refund you receive later so you can get more take-home pay now--and funnel the extra into savings.
Cut your spending. Make a list of what you spend every day, and look for a few things to drop, such as those gourmet cookies. “Take your lunch to work, don’t buy it,” Pond suggests. “That could save you $1,000 a year, $4 a day.”
Cut out your expensive vacation, or take a cheaper one. Give thoughtful handmade gifts instead of fancy crystal. Make a budget and stick to it.
Make sure your rainy day funds are in safe investments that are quickly turned into cash. Such investments include federally insured savings accounts (but be careful about certificates of deposit, because of early withdrawal penalties). They also include Treasury bills, which mature in one year or less, and most money market mutual funds.
Be wary if a lot of your wealth is tied up in assets not easily convertible into cash. In a recession, it may be hard to sell certain hard assets, such as investment real estate or limited partnership shares.
Accordingly, if the tax impact is manageable, consider selling some of those assets now to raise cash.
Meanwhile, make your debt manageable and reduce it if necessary. High debt can be a burden--even a disaster--in a recession.
As a rule of thumb, your debt payments should not be more than 35% of your gross income if you have a mortgage, and not more than 10% if you don’t.
If you exceed these levels, absolutely DON’T add to your debt. Dump one or more of your credit cards. Postpone buying that new car. And don’t borrow for anything “perishable,” such as a vacation.
Start paying down your debt only if you have saved enough to amass three months’ worth of income in your rainy day fund.
If your borrowing problems are serious, you might want to contact a local office of Consumer Credit Counselors, a nonprofit organization that can help you manage your debts and work with creditors to develop a repayment program. The National Foundation for Consumer Credit in Silver Spring, Md., at (800) 388-2227, can provide a referral to the nearest office.
But be careful to avoid so-called credit doctors or credit-repair clinics that offer to fix your credit for a fee. Those fees can be hefty, and they usually don’t do what they say they’ll do.
Finally, make your retirement savings less vulnerable. A recession increases the chances that your employer could go bankrupt of suffer other dire consequences.
Thus, if you are in a 401(k) company savings plan, be sure that your funds are not all tied up in your firm’s stock or bonds.
EXPENSES TO ANTICIPATE Do you often fail to anticipate large, less-than-monthly expenses, and find yourself unable to pay them? To avoid that, author Jonathan D. Pond suggests setting up a separate savings account to cover less-frequent expenses. Take the following list of expenses and calculate what you’ll need for each category:
Property taxes
Homeowners/renters insurance
Life insurance
Other insurance
Home improvements or maintenance
Furniture
Seasonal fuel/electricity
Vacation
Christmas/holidays
Tuition
Club membership dues
Charitable contributions
Estimated taxes
Retirement plan contributions
Other
