The Financial Parachute

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picture from businessinsider.com

The cover story of the May 2016 issue of The Atlantic reported on a survey conducted by the Federal Reserve Board. Although most of the survey questions resulted in common responses that were expected, there was one question that stood out. The survey asked participants how they would pay for a $400 emergency. About 47% of people said they would have to borrow money, they would have to sell something, or they would simply not be able to come up with the $400 at all.

If you’re a young adult, then that might make sense. No one expects young people starting on their adulthood journeys to be financially secure (especially college students who often struggle to find $400 for textbooks.)

But as you get older, it becomes highly important necessary to have what I call a “financial parachute.” A financial parachute is a certain amount of money set aside to take care of yourself just in case of an unexpected emergency. (I suppose all emergencies are unexpected…it’s part of what makes them emergencies.)

Having an emergency fund is like having a parachute. You hope you’re never in a malfunctioning plane that’s going down, but if you are, then your next hope is that there’s an available parachute that’s built well enough to guide you safely to the ground. In your financial situation, picture your monthly budget as an airplane flying smoothly through the sky. Losing your job is like having complete engine failure on your airplane.

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If you’re smart, you should have some questions (three questions, to be exact). 

Question #1: How much money should be in a financial parachute?

Experts say you should have an emergency fund healthy enough to pay for three months worth of bills and living expenses. Maybe it’s my own fear and insecurities, but I think that those experts are not being realistic enough. I think you should always be working toward building an emergency fund that has six months of your income. At least six months.

Having at least six months of emergency money gives you a little peace of mind should you ever find yourself out of work. It gives you a half-year to hustle enough to find a new job or even leave the rat race altogether and strike out on your own.

Question #2: So how long does it take to build a financial parachute?

The answer to this question depends on how much money you can save each month. A lot of people can’t save anything. If, for example, you bring home $1,500 each month, but you also have $1,500 worth of bills and expenses, then building a financial parachute is not your priority right now. Instead, you should be figuring out a way to get rid of some of those expenses.

But let’s suppose you want to build a three-month emergency fund. If you have $1,500 worth of monthly expenses, then your goal is to save $4,500 total. If you can only save $200 each month, then it’ll take you a bit less than two years to reach that goal.

The general rule is that if you want to build a 3-month emergency fund, but you can only save 10% of your money each month, then it will take about 30 months.  If you can save twice as much money, then you can do it twice as quickly.

Now I know you. I know exactly what you’re thinking. You’re thinking that it’s impossible to even put aside any money at all. And you’re probably thinking that even if you could save money each month, what happens if an emergency hits early before your financial parachute is fully funded? I know, I know, I know. I had those same questions too. That leads me to…

Question #3: So what are the steps to building a stable financial parachute?

First things first–determine the target. Based on your monthly income (assuming you have one), calculate what your ideal emergency fund should be.

Second, open a savings account at a bank located in an INCONVENIENT place and choose to NOT get an ATM card. For example, I opened an account at a credit union (because I didn’t want the ridiculous fees), and the nearest branch is a 20-minute drive from my house. I made sure to tell the bank rep that I did not want an ATM card because I didn’t trust myself to keep my hands off the savings.

Third, make things automatic. Talk to your job’s human resources department. There’s a simple form you can fill out so that any amount you choose will be automatically deducted from your paycheck BEFORE it even gets to you. This is important because you don’t miss what you don’t see. (That bears repeating…you don’t miss what you don’t see.) Each month, your emergency savings will grow without you doing anything. And because it happens BEFORE you get your paycheck, you won’t feel the hit. Start with any amount you can afford…you can always increase it at anytime.

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Here’s the beautiful thing about your emergency fund. I know it doesn’t feel like it right now, but thirty months will really fly by quickly. And if an emergency happens early before you reach your target, at least you have something to work with (and something is much better than the “nothing” that most people are saving.)

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