One lesson of the recent recession is the importance of stashing away cash in case you lose your job, your investments falter, or you’re hit with some other calamity.
It’s a lesson that many Americans have taken to heart. Consumer Reports Money Adviser reports that savings as a percentage of disposable personal income climbed to 5.9 percent in 2009 from 2.1 percent in 2007, according to the federal Bureau of Economic Analysis.
In a spring 2010 survey by the Consumer Reports National Research Center, 43 percent said they were putting more into savings.
The editors of CRMA offer the following tips on how to amass cash for emergencies and future purchases:
Set a goal
But how much should you save, and where should you keep the money?
A reasonable goal is to save six months of living expenses, perhaps more while the economy remains sour.
But the amount that makes sense for you depends on a number of factors, including your job security, your health and the quality of your health-care coverage, and how much debt you have. Other considerations include the number of wage earners in your household; whether you have dependent children; and your access to emergency sources of credit, including home-equity lines and even family members.
An emergency fund will help you keep your household running if you lose your job or face any other costly crisis without having to borrow, especially in a tight credit environment, or cash out your investments at what could be an inopportune time.
To avoid the temptation of spending that money, create a separate capital fund for big-ticket expenses you expect within the next five years, such as a new car or a down payment on a house.
Consumer Reports Money Adviser recommends taking a hard look at where your money is going — your fixed expenses and your discretionary spending — to see where you might free up some cash to put toward savings each month.
Your basic living expenses, including mortgage or rent, utilities, insurance, food, and clothing, should equal no more than about 60 percent of your income. The remaining 40 percent should be for discretionary spending, savings, retirement, and investing. If your living expenses exceed that, consider changing your lifestyle or finding sources of additional income.
If you’re like many people, you’re already making regular contributions into a retirement fund and perhaps building funds for your children’s education. If your emergency fund is inadequate, you might need to adjust those contributions, along with discretionary spending. But try not to reduce your retirement contributions below the threshold for getting your employer’s full 401(k) match.
Don’t tap your retirement funds or college savings if you run into an emergency, because it can be costly. You’ll pay income tax on IRA withdrawals, and if you take them before age 59-1/2 you might be subject to a 10 percent tax penalty. The same applies if you borrow from your 401(k) or 403(b) and don’t pay it back within five years.
Once you determine how much you can set aside, have the money taken out of your paycheck automatically and direct it to your emergency and capital funds. Build your emergency fund before putting anything away for big-ticket items.
Where to keep it
Emergency money should be deposited where you can get to it quickly. According to Consumer Reports Money Adviser, the safest place is in a bank savings account. You can find the highest-paying accounts by checking the national savings and money-market rates at Bankrate.com. (Sort results by APR.) Also check the websites of local banks and credit unions, which might have higher rates than national banks.
You have more flexibility with money you’re accumulating for a major purchase several years from now. You might put the money in CDs and short-term Treasury bills and bond funds.
Once your savings goals are met, reallocate money to investments like stocks, bonds, and mutual funds. Those are generally appropriate only for cash you won’t need for at least five years.
Filed Under: Consumer Reports