Expand Your Understanding of the Investment Possibilities that Exist
Most people in the western world have an overly narrow view when it comes to investing - they usually think one of those places for storing money:
Even the above list is broad - most young people today don't readily buy bonds or invest in bond funds (even though the overall bond market is bigger than the equities market). Unless you're lucky enough to have had your grandma buy you a bond, you've probably never owned one and you might not even really know how one works.
So, that leaves us with equities or cash - is there nothing else? Of course, there is something else -- most people have been doing other things with capital rather than buying equities or saving cash -- throughout history. You just have to open your eyes to the broader investing and capital allocation universe that's out here.
Of course, you shouldn't be foolish - equities (eg. stocks, mutual fund, and ETFs) and cash are better understood and offer a lot of advantages. But a person can also invest in:
getting even deeper and more complex, you can invest in things aren't aren't even assets but things that might bring a return later on. These might include:
Again, no one here is saying that you should forget the bread and butter that cash and equities offer the broad swath of the investing public - far and away these should (for most people and in most situations) make up the majority of your saving and wealth-boiling plan. However,r it's smart to lift your head up once in a while to see other possibilities and opportunities available if only to build a better and more comprehensive understanding of what capital allocation, investing, growth, return, and success really mean in your overall financial life.
You can't save your way to riches if you don't have a big enough income to save just like you can't dig a big hole if your shovel is tiny. Too many people, too many financial websites, too many financial advisors, too many financial shows have for too long advocated saving with a deep lack of attention to the more important sid of the equation: INCOME.
Of course, even if you have an enormous income but still manage to spend it all, you won't build wealth. But that is not at all relevant to what we're discussing here. What we're saying is that there are simple mathematical and physical principles govern the world we live in and based on these principles there's something we know that's true:
the maximum amount you can save is your full income - this would be not possible in most cases it would require not spending anything
So, if you're earning $30,000 a year but are the most magnificent saver in the world, the most you can possibly save is $30,000 but realistically you'll be considered an ultra-saver if you manage to save $20,000 a year.
Contrast that $30,000 per year example with someone who earns $300,000 a year - clearly that individual has a much bigger shovel and has a lot more room to take advantage of saving. In effect, this person who makes $300,000 can benefit more from saving because the more he/she saves the more they can put away for building wealth up to their income. In effect, if they can spend $10,000 a year like the person in the $30,000 example, they can save a huge pile of money every year and build a lot of wealth.
People should be focused on saving, but they should equally (if not more intensely) be focused on generating more income for themselves os that they can put more money aside. This is easier said than done and that's the reason most financial resources tend to focus on saving rather than increasing income - everyone simply wants to pick the low-hanging fruit.
In Antiquity, Family and Community Provided a Safety Net in Retirement
Throughout most of human history, the idea of retirement as we know it today didn't exist. People simply worked their entire lives either hunting and gather or farming (after the Agricultural Revolution) -- if they were lucky enough to survive into adulthood -- and when they were too old to work, they relied on their families to take care of them. An old person might rely on younger siblings, children, and nieces and nephews within the family or community to take care of them. While doing this they probably still had to do some work - the idea of not working at all is a deeply modern notion and even very old people in ancient times still likely cared for children, did chores around the house, and performed other familial duties (eg. arranging marriages, representing the family to other communities, and advising younger family members).
Although life was incredibly harsh with humans having to face both natural disasters and man-made dangers in the form of banditry, war, pillaging, or abandonment, most human societies operated in a way where the elders and those who were unable to work were taken care of by family. As time moved forward and as humans settle down this was more and more true - while a hunter-gatherer tribe might leave an old person to die, a farming community would likely be able to provide for the elderly because life was calmer and a bit more stable in terms of movement and physical danger.
Obviously, no one in their right mind living in the first-world should want to go back to a hunting and gathering lifestyle and especially a farming lifestyle (as farming was likely worse than hunting and gathering for overall human well-being). However, we can't deny that the family bonds that existed in the past that effectively created an organic safety net for the elderly no longer exists today.
Safety Nets Such as Welfare Provide Retirement Security in a Changed World
As the world moved forward modernized, nations around the world began creating public, centralized welfare systems to take care of those who were too old to work and had to enter a stage of retirement or diminished income-earning capability. In the United States, during Roosevelt's New Deal during the Great Depression, the Social Security system was created - this was a system where old people who were no longer working could receive income from the government (meaning from those who were earning income). In effect, this wealth-transfer mechanism sought to replace the old traditional familial and community retirement safety nets that had long since been eroded over the centuries following the Industrial Revolution.
It is difficult to argue that a safety net for old people who can no longer produce income through their labor and who don't have a large enough retirement nest egg to live on is a prudent idea - it is deeply natural to humanity to take care of one another. The difference is that instead of taking care of each other locally, we started taking care of each other on a grand national scale. This creates its own problems and perverse incentives, but it fundamentally is in line with our human nature. If done in a prudent and conservative way (something that is far from guaranteed), such a retirement safety net can at once benefit the economy through stabilizing things and benefit society through creating a better and healthier moral landscape by taking care of retirees.
Retirement Saftey Nets in Jeopardy - Self-reliance is Key
However, today the Social Security system -- a system that hasn't even been around for a century -- seems to be in jeopardy (it is projected that in 2037 Social Security trust fund reserves will be exhausted and where 100% of payments will no longer be able to be made). A system designed at a time where there were few retirees living into their 60s and 70s compared to the working population is under stress in the world where Baby Boomers are aging rapidly with access to world-class health care that will allow them to live into their 80s and 90s reliably and in good numbers. Many believe this system will not be able to sustain itself. This will be further exacerbated if unemployment increases over the coming decades due tot he rise of artificial intelligence. Young people today should not rely on Social Security to be around when they are old and gray - that is now a foolish proposition.
For young people today, the idea of retirement is different than for almost all past generations. For the first time in history, neither (1) the familial/community structure that effectively provided retirement benefits for the old nor (2) the retirement benefits provided by welfare systems like Social Security is likely to be around when today's young men and women reach retirement age.
So, we're now in a world where the old family and community structure have long since been almost totally wiped out and where the retirement safety net that came in to replace that old structure is itself in peril. We are facing a troubling and dark world when it comes to retirement - we have neither one nor the other, we only have ourselves at this point. Although a fix might occur and things might turn out well, in the end, any prudent person who is under the age of 40 should discount Social Security and only rely on himself/herself to provide in old age and retirement. This requires changes - it requires a discipline that might not have existed in the last century for most of the population in term of saving. Young people must be diligent and disciplined savers and investors if they are going to be able to amass a nest egg large enough to support them through what could be decades of retirement.
This means that saving 5% or 6% in your 401k to get your employer match, putting $5000 a year into an Investment Retirement Account (IRA), or simply having a nice cash cushion in the bank is not even close to enough. Saving rates must far exceed 10% and should approach 25% if young people today are going to be able to comfortably retire. Additionally, effort and energy must be put in to invest the savings in a smart way - saving cash will not be sufficient as growth is going to be needed over time in order to build up a nest egg.
Compound interest is something we all know about, but not something we fully grasp. Sure, most people in the developed world in 2017 know what compound interest is and what that it's a pretty powerful thing, but few know exactly how powerful it is. There's a rumor that Einstein said something to the effect of "compound interest is the greatest force in the universe." If that's true, he was a smart man.
So, how can we approach a better understanding of compound interest? There seem to be two possible approaches here:
It seems that both are important, bu that the examples always are better in getting the ball rolling. Some examples are so astonishing that students of finance and financial theory are in awe both at the power of compound interest nad the previous disrespect for it. Here is one such example for your entertainment and pleasure.
Let's imagine 3 scenarios:
So, we've got 3 scenarios here, with each person separated by two main differences:
So, we know what's different, but what is the same? We have a few things that are the same for the people in all 3 scenarios:
So, we now have what we need - we have 3 babies born on the same day in the same hospital to different families. Let's take a look at how things turn out for them over the course of their lives.
We first notice that the baby in the Ideal scenario starts accumulating wealth - although not very much. In the first year, $1200 is saved. By Year 10, however, almost $20,00 has been accumulated thanks to the 10% growth. Another 10 years goes by and by Year 20 the Ideal baby has accumulated almost $69,000 - a very significant sum especially given the fact that the parents have only saved/invested $24,000 over the course of those 20 years.
Now, let's move to Year 25 - the Optimistic baby is now and adult and is joining the pack here. Unlike the Ideal adult who now has a lot of cash at Year 25 (about $118,000), the Optimistic baby has nothing. However, the Optimistic baby is saving 10x what the Ideal baby is saving - that's $1200 a year vs. $12,000 a year!
So, let's observe these two over time. At Year 30, the Ideal adult has roughly double the amount the Optimistic adult has (that's about $197,000 vs. $93,000). This might seem not astounding unless you realize that the Ideal adult has only saved/invested $36,000 over the course of his or her life while the Optimistic baby has already (over the course of just 5 years) invested $60,000.
Continuing through to Year 50, where the Typical adult finally joins us, we see an interesting situation - the Ideal and Optimistic adults have roughly caught up with each other. Each has about $1.3 million, BUT the astounding part is only revealed when we think about how much each has saved/invested over the course of their lives:
Now, we've got everyone in the game - the Ideal, the Optimistic, and the Typical adults. Let's follow through until 65 - they have 15 more years to save and growth their wealth.
Catching up with all of them at 65, what do we see? We see a few interesting things, but first, let's start with the numbers:
BUT, let's again sit in awe of the power of compounding by taking a look at how much each saved/invested:
So, we see that they're all very wealthy, but they've achieved their wealth in very different ways. While the Ideal person barely saved anything throughout their life, the Typical person saved a ton. Digging deeper, we can see that the Ideal person actually saved less in their entire 65 years than the Typical person saved in one single year. This is truly astounding and provides excellent evidence at the amazing power of compounding.
We can see that time matters a lot. In fact, this example clearly shows that in many cases, time matters more than money. The one who started first finished ahead of everyone and barely had to save anything. The Idel person could have earned $40,000 their entire lives with no raises at all but would still have more money at 65 than the Typical person who had to earn enough from 50 to 65 to be able to put away $120,000 per year (that's very hard considering that savings comes after expenses and after-tax for the most part). The Typical person would probably have to earn at least $400,000 per year to be able to reasonably save that much money - even at that level of income saving $120,000 per year would feel like an incredible sacrifice.
Take a look at the table below for a rundown of all the numbers. You'll see the age of our group on the left along with the savings rates and rates of returns at the top.
If you cannot save money, the seeds of greatness are not in you.
To become an excellent saver over the long term you must get some sort of mental reward from saving - if saving is a difficult process (like resisting eating food when dieting), you might be able to do it for a little while but over time you'll fail because we all only have limited amounts of willpower and energy. The real secret to being an amazing saver is to love saving - the secret is to have saving be a very enjoyable thing.
For some people saving money is very easy - they were either born with a mind or a disposition that rewards them when saving or they developed such a mind or disposition over time. Rarely will you see a really excellent saver who has to consistently battle himself or herself to put money away for the future or to resist spending in order to save - it's just too hard to do over the long term.
Other people, however, just can't seem to save. They spend all of their incomes (and sometimes even more) and they don't seem to feel any reward by putting money away - it feels like a chore to resist spending all of their money or putting some money aside. They won't become wealthy unless they strike it rich through luck or unless they have extremely high incomes. For most people who can't seem to enjoy saving money, they will need to change their mind a bit in order to be able to become truly excellent savers capable of building real lasting wealth overthe long term.
How can you change your mind? That's the hard part. You'll need to force or will yourself to start saving at first despite any internal resistance you have to it. When you do save some money, take the time to sit down and think about what you just did:
Reward yourself with a nice dinner, a nice movie on Netflix, or anything else you enjoy. Let the pleasure sink in and try to associate the pleasure with the act of saving money. Do this consistently and over time saving will seem more pleasurable and easier.
Here are some other tips to help you become an excellent saving:
Now, it's possible that not everyone can be an excellent saver - as much as we want it to be true, it seems like some people either don't have the personality or the internal energy to become excellent savers. That's a sad proposition. However, if you're reading this post, you're very likely not one of those people - you've already shown excellent initiative and you're already ahead of the game in your search for high-quality information. Go out and practice the tips above with vigor and intensity until you saving feels amazing for you also.
Living below your means is absolutely required if you are to build wealth, gain financial independence, and live a life of dignity. However, too many people fail to live below their means even though they intuitively know that they should do so. Are you one of them? Below are 3 powerful tips that will help you live below your means and set you up on the path to financial prosperity and wealth.
1. Make Saving and Investing Automatic
One of the most effective ways to live below your means and save more money is to put your savings and investments on autopilot - have your saving program and investing program draw money from your transactional account (usually your checking account) before you can get to the money.
So, for a typical example, let’s take a look at an hourly or salaried employee who obtains all of his or her income from his or her job. Let’s say they get their pay via direct deposit into their checking account every 2 weeks (this is the most typical payment timeframe). They should set up a system so that it automatically withdraws money from their checking account either every two weeks or once a month. Such a system is very easy to set up on most online savings accounts and online brokerages - once your accounts are open, it usually will take you less than 20 minutes to set something like this up.
Automatic withdrawals into a savings or a checking account almost always beat manual withdrawals into those accounts because of issues presented in the field behavioral finance. Humans are prone to procrastination, forgetting, getting lazy, or getting distracted - the algorithm or computer program that will be in charge of executing your automatic withdrawals will not be prone to such things (although it could be prone to computer bugs). You might think you’ll be able to consistently save and invest every month, but if you look at what people really do in the world, you’ll see that too many people fail themselves and their financial plans at some point in time. Usually, it doesn’t take very long for them to fail and not make the monthly or weekly transfer or stock purchase they committed to making. With an automatic investing and savings plan, however, you’ll turn your human faults into advantages - the same procrastination and laziness which would prevent you from saving and investing money will also help to prevent you from going into your online savings account or online brokerage to change or remove your automatic savings and investment plans.
2. Understand that Many Significant Expenses Don’t Occur Monthly
We’ve written about this a bit already on Pennies and Pounds, but it is worth restating often. Only a portion of all of your expenses are monthly expenses - other expenses occur once a year, once every few years, once every five years, once every decade, or once in a lifetime. These expenses are not financial emergencies because we can predict them (eg. you know you’ll have to pay your child’s college tuition or you know you’ll have to pay for a wedding).
Click here for more on non-monthly expenses and an extremely in-depth explanation on why you must save a lot of money and build up a pile of cash!
Since we know that many expenses (especially the big and important ones) occur very rarely (but predictably), we must save for them if we are to be prudent adults. Anyone who is serious about building wealth and attaining financial independence cannot ignore this important fact about our current financial reality - that not all of our expenses are monthly. Ignoring this fact will cause you unnecessary stress and anxiety down the road and might cause you to have to either dip into your emergency fund or your investments for something that you should have (and could have) planned for.
Realizing the above should motivate you to live below your means in order to save. We must all realize that our monthly expenses are just an illusion (they don’t represent the full reality of our expenses over long stretches of time) and we must live below our monthly means in order to save for future expenses. It’s pretty interesting that before even taking investing and wealth building into account, we still must live below our monthly means in order to just break even over the long term - if you spend your entire monthly (or biweekly) income you are actually overspending. For example, multiplying your monthly expenses by 120 would severely underestimate how much you’ll need to spend over 10 years because you won’t be taking account those big expenses that occur once every year, once every five years, or once every decade. If you’re spending your entire monthly income you are doing the equivalent of going into debt except you are borrowing from your future self who will have to struggle and strain to make up for your lack of forethought and planning today.
3. Imagine and Connect With Your Future Self
At Pennies and Pounds, we value research but we also value common sense, good stories, and tradition - we're not religious about research like many people are in today’s modern world because we are aware of the games that can be played with research and the various biases and agendas that can influence studies. We also know about the games that can be played with statistics. Have you heard the following saying?: “There are lies, damn lies, and statistics." We won’t go into it deeper than this in this article, but we wanted to let you know our views on research before we proceeded with the following point.
New research is showing that when people are better able to “connect” with their future selves, they will make better long-term decisions including financial decisions. A piece by the Harvard Business Review on the study can be found below. We encourage you to read HBR’s piece and look at the actual research study if you are so inclined. In very general terms, the research implies that people generally have a disconnect with their future selves - people don’t really understand that their future selves are themselves. This might sound funny, but it’s true in a way. The research showed that people are more willing to commit to things in the future and are also more willing to commit other people’s time. It’s almost as if they view their future selves as a different person.
It’s astonishing in a way, but the disconnect described in the research between your current self and your future self sort of makes sense. Have you ever committed to something in the future only to realize how foolish you were to do so when the time to actually execute on that commitment comes around? Have you ever set an alarm to wake up extra early the following morning only to hit the snooze button and wake up at your normal time (or wake up late) when the time comes around? Have you ever promised yourself to save more money or spend less money only to not follow through when it’s time to actually have the discipline to follow through? The research suggests that this occurs because it’s as if you’re committing another person to something when you’re making a future commitment - it’s easy to commit your future self to a project if it’s a year from now because it is as if you’re not really committing yourself but are instead committing another person. If you had to execute on things immediately, you would be far more cautious about what you promise to other people and to yourself and you would feel the weight of your actions (or inactions) much more.
All of this is to say that if you can better connect with your future self, you are more likely to make better financial decisions - you’re more likely to save money today and live below your means today because you’ll have a better connection with the future you who will one day benefit from your smart decisions today.
In the study, researchers used MRI and sophisticated aging techniques to present participants with photos of their aged selves. This is very expensive and difficult for us to do, but there are other techniques that can help. You can simply sit and imagine yourself in the future or you can write a letter from your future self to your current self. Additionally, there are apps available that can “age” your current photos. Check out one such app below. Your connecting with your future self doesn’t have to be complicated or sophisticated - it just has to help you realize that it’s not some distant other person that will benefit from your positive actions, it’s you who will benefit.
We once again will stress this important point because we believe it cannot be said enough - you cannot be satisfied by living at your means, you must live below them if you are to truly build wealth and become prosperous. As is stated above and in other places on this website, you must live below your means because:
Don't foolishly fall into the trap that derails many financial plans and needlessly taps into people's emergency funds: mistaking a non-emergency for a real financial emergency. A financial emergency is something unexpected, not something that predictably happens every so often.
Read our comprehensive article on emergency funds for more on the randomness of life and how so many things are unpredictable (that's why we have to have an emergency fund)
Here's what unexpected means: that you cannot reasonably anticipate the nature of the financial emergency in advance. You can of course anticipate that a financial emergency will occur based on the nature of our reality and existence, but you cannot reasonably predict what it will be.
Therefore, the following would not properly be considered financial emergencies:
The above are not emergencies because we can anticipate them - we have anticipated them for you and we don't even know you.
Real financial emergencies, however, are things that we think might happen, but things we cannot predict in any reasonable way from where we currently are. We know we might get a flat tire or injure our ankle, but we don't know if that will ever happen, when it could happen, and the financial cost of it.
Do not confuse rare expenses with financial emergencies - you will not be served well by doing so because you will consistently fail to build lasting wealth if you dip into your emergency fund to pay for things that are not at all emergencies.
In order to have a successful and prosperous marriage with the one you love, your marital finances must be in order and you must both be on the same page regarding money and how your household will approach it. Read the 8 things to do before getting married below for a comprehensive guide on getting financially prepared before your wedding.
1. Have a Conversation (or many) About Your Views on Money
If you’re engaged and planning on getting married, we hope you’ve already had all of the important conversations that a couple needs to have before tying the knot. Such conversations include discussions about:
One important topic that should be included in the above set of important premarital discussion topics is (but is surprisingly often not included) is a conversation about money and finances. We’re not sure why this is and we only have anecdotal evidence for this statement, but it seems that couples have an easier time discussing things such as how many babies they want, their religion, or where they want to live than they do discussing money, finances, personal spending and saving habits, and financial goals.
In order to maximize your chances of having a happy and prosperous marriage that creates wealth and prosperity for your household instead of poverty and stress, it is wise to have multiple discussions about money and how you relate to it before your wedding. These discussions don’t have to be formal in any way nor do they have to be very technical or sophisticated, but they must be honest and they must be courageous - you must not be afraid to tell your love and future spouse how you feel about all things related to money or finance.
Here are a few points you should cover in the conversation(s):
These discussions should be loving - you’re not fighting or trying to change your future husband or wife very quickly. You’re not going to not get married to someone you love just because they are an over-spender and because they are terrible at handling finances - although you will want to help them change so that you can have a happy and prosperous marriage. Remember you’re speaking to the one you love and the one you must care for - allow that to color your conversations.
Although you want to be loving and compassionate, you also don’t want to be too weak and overly understanding - your love for the other person requires that you help them become a better person in every way and that includes a better person financially. Additionally, money is important to a marriage (many marriages fall apart due to financial issues) so you’ll want to guide your relationship and your future household to a better financial place in a courageous way - you must muster the courage and the energy to improve things if your future husband or wife isn’t financially savvy or financially intelligent (or if they are financially irresponsible). A marriage isn’t just an economic partnership (it isn’t any longer at least - and it shouldn’t be if we are to realize our true potential as loving human beings) where each has an equal say in how things go. A marriage is (or, at least, should be) a sacred bond between two people in our modern Western culture that gives each partner a certain right to influence things and influence each other beyond what would be allowed in an equal partnership. It’s not that each of you owns 50% of your marriage - each of you owns 100% of the marriage and that ownership gives you a sacred right and a sacred duty to improve the relationship and improve the other person where they are weak or lacking.
2. Reveal All Debt to Each Other
This is simple but can be difficult to do if you have a lot of debt that you have not previously revealed to your partner (usually because you were afraid of being judged for it).
Hopefully, you’ve already revealed all of your debt to each other earlier in your relationship, but if you haven’t the first step is to find out all of your debt yourself. It’s surprising to see how many people don’t know their full debt balance themselves. If you’re not totally sure about how much money you owe, look into the following:
Once you’ve assembled a list of all your debts (this is an exercise that will prove very useful beyond just this step), communicate it to your partner. Your partner should do the exact same thing.
If you are hesitant to do this because of some sort of fear - stop being scared and even if you are scared, do it anyway. You’re going to marry this person and have a life with them - it is not acceptable for you to be willing to do all of the things that come with marriage and to commit your life and energy to this union but be unwilling or to too afraid to reveal all of your debt.
Revealing all of your debt to each other before marriage is a wonderful exercise. It might cause some drama or tension at first if things weren’t previously revealed, but once things are in the open, your relationship will improve because you will no longer be hiding things in your financial closet. Additionally, you will have set yourself up for a prosperous and happy marriage because by being aware of your household’s debt load, you will be in a much better position to deal with it and to gradually eliminate it on your way to building wealth and achieving financial freedom. A household that is confused about how much money it owes cannot be a financially successful and prosperous household.
3. Reveal All Assets to Each Other
This one should be easier than Step 2 if you have a lot of debt, but you still might find some resistance if you have a lot of assets. That’s somewhat understandable, but you must ask yourself what marriage really means to you and what you want from this marriage if you are unwilling to tell your future spouse what your current asset holdings are. Assets include everything you own (eg. cash, stocks, bonds, real estate, gold, silver, private business interests, etc.).
Marriage means combining everything - including your assets (unless you have a prenuptial agreement - more on that in Step 8). That means that when you get married, from a philosophical perspective, everything that belongs to you belongs to your spouse. Legally that may not always be the case, but we’re not talking about marriage law here - we’re talking about what marriage means beyond the letter of the law and what will set you up for a successful, prosperous, and happy marriage. If your partner is going to inherit everything you own when you’re married, shouldn’t they be aware of what you own today? Isn’t it much wiser to prepare each other for what is to come than live in some dark illusion?
Again, some people might hesitate, feeling that they should keep their assets separate or feeling afraid to reveal how much or how little money they really have. That is possibly understandable, but it cannot become an excuse to avoid this very important and very necessary part of marriage - combining everything with your husband or wife. If you cannot allow your future spouse the knowledge of what you have, how can you possibly enter into the sacred bond of marriage with them?
Of course, if your spouse has proven to be very irresponsible with money and reckless with finances, you might be unwise to go beyond just revealing what you own. In that case, you’ll still want to reveal your assets, but you will want to make sure that you are in total control of them now and possibly even after marriage. This will prevent your newly formed household from misbehaving with money - if your spouse misbehaves with money your household misbehaves with money. This can become a touchy issue if your future spouse is very irresponsible with money because he or she isn’t likely going to easily accept you simply revealing assets but not allowing them to control them in any way. If your spouse is prudent, mature, and honest with himself or herself, however, they will likely understand that they have proven themselves to be an unworthy recipient of control over of a lot of money or a lot of assets - they’ll understand that you are somewhat justified in your caution and that they’ll have to slowly prove to you that they have changed their ways and are committed to being in a healthy and prosperous union with you. If they don’t understand, however, you’ve got a bit of an issue on your hands that is now out of the realm of personal finance and household finance and in the realm of relationship problems - you might consider seeking some sort of relationship counseling or premarital counseling before tying the knot in such an unpleasant situation.
4. Check Each Other’s Credit (FICO) Scores
This is a simple one and should be easier than both Step 2 and Step 3 because it’s not as important for your financial future - although your FICO score (aka credit score) is somewhat important, it isn’t nearly as important as cold hard assets and the debt that you owe in determining your household’s financial well-being and financial future.
Here are are few reasons why a good credit score is important:
The good news is that once you’re married you’ll be able to rely on your spouse’s credit score if theirs is good and yours is bad (assuming you are both applying for the financing). If both of you have poor credit, however, then you’re in a tough situation because you might find it difficult to finance purchases (and do some other things that might require a good credit score) in the first few years after marriage until you two are able to rebuild your credit.
Remember, there’s a fine line between being too concerned and not concerned enough about your FICO score and credit history - be concerned but don’t obsess over it or think that your credit score is the most important thing in your financial picture. Your abilities to earn a solid income, to live below your means, to save money, are far more important than your credit score because they actually determine how much money you have in your pocket and in the bank - a credit score is only a number that is supposed to predict your creditworthiness (how likely you are to repay a loan) but you can’t live on your credit score - your credit score doesn’t pay your rent or put food on the table or pay for your vacation.
You can check your credit score in a variety of places. One free service is Credit Karma, although there might be other (possibly better) options out there.
5. Save to Pay for Your Honeymoon in Cash
After your wedding, if you plan on doing a honeymoon (there’s nothing wrong with not doing a honeymoon or postponing it), make sure you pay for it with cash - do not go into debt to pay for a vacation (yes, a honeymoon is a vacation) no matter how important you think it is.
You will be making a big mistake if you finance your honeymoon with credit cards and other forms of debt. You’ll return from the trip but you’ll be stuck with the debt for many months or possibly years. The debt will prevent you from achieving other financial goals and the debt will be attached to a vacation you already took - you won’t able to go back and “sell” the vacation as you would be able to sell your house if you decide it was an unwise purchase. If you pay for your honeymoon with cash, however, you’ll come back home calm and you’ll be able to continue your financial program (or start one) as a married couple and you won’t have to first pay down thousands of dollars of useless credit card debt - debt that was incurred for a luxury purchase.
If you do have the cash to pay for the honeymoon, however, don’t hesitate to use the money you’ve saved up on a nice (but reasonable) honeymoon with your future husband or wife. Some financial nerds and super-savers might think it’s better to instead invest the money rather than spend it on a honeymoon after a wedding. While this might be a good move when considering only your financial life, your spouse (who might not be a super-saver or might really want a honeymoon) might find the entire notion of foregoing a honeymoon to instead save or invest the money very unromantic and they could be disappointed with such an idea. Remember, life isn’t just about your net worth. So, if you’ve got the money for it and it’s something you two want to do, do not hesitate to take a honeymoon with your new spouse and don’t feel even a little bit guilty about doing it - enjoy your honeymoon and remember that the only reason we want a lot of money and a lot of wealth is because we want to help people and have amazing experiences in life. Money for money’s sake is really a pointless and dark proposition that won’t make neither individuals nor societies truly rich in the broad and proper sense of the word.
Additionally, do not tap into your emergency fund to pay for your honeymoon. Tapping into your rainy day fund to pay for such a luxury is almost as bad as going into debt to pay for it - you know very well that a honeymoon is not considered an emergency.
6. Save for Moving Expenses and New Furniture
Most couples do some sort of living space change after marriage - either you’ll move in together or you’ll move somewhere new if you’re already living together. You’ll want to save up for any possible moving or moving-related expenses and pay for them with cash. Whether you’re just planning to buy a new couch for the living room in the apartment you currently live in or you plan to buy a new house in another country, if you anticipate some expenses for settling in together as a married couple, save for it immediately and aggressively to make sure you can pay for it all with cash. Do not make the mistake of burdening your new marriage and your new combined financial house with useless debt.
7. Consult with Family About Potential Help You’ll Receive from Them
Some new marriages are lucky enough to be blessed with financial support and financial assistance from parents, grandparents, or other family members. If you’re lucky enough to have parents or in-laws who will help you start your married life by contributing financially, be thankful for this and resolve to use your luck and their assistance as wisely and as prudently as you can.
It’s a good idea to speak to your parents (or other family members) well before getting married to understand how much they will:
Generally, each person should speak to his or her parents alone without the presence of the other future spouse - this makes things much more proper and pleasant for everyone and is in line with common courtesy. You know your parents and you should have an idea of their financial means and what they think they’ll contribute already so you shouldn’t be too surprised after the conversation(s). The point is to understand what’s going to happen so you can effectively plan for the future together.
8. Discuss Prenuptial Agreements and Make a Decision
Some people come into a marriage with substantial assets or with substantial incomes and wish to protect their assets or future incomes in the case of divorce. We won’t go into whether prenuptial agreements are “right” or “wrong” here, but you’ll want to discuss a prenuptial agreement with your spouse in a very tactful, respectful, and loving way if you want a prenuptial agreement set up before entering marriage.
Some people view prenuptial agreements as unromantic no matter what assets each partner brings into a marriage and no matter what incomes each person earns. Make sure to understand this if your partner is opposed to it. If you’re opposed to it and your partner wants a prenuptial agreement, understand where they are coming from as well. Prenuptial agreements are popular and most couples generally are able to relatively easily agree about having or not having one, but sometimes the issues can get touchy when a couple has never discussed this and when one partner has a disproportionate net worth and income relative to the other. Usually, prenuptial agreements are more popular among older couples, as younger couples often have not had the time to build enough wealth or develop high enough incomes to make a prenuptial agreement very useful.
Remember, your financial life is only a part of your life. The above 8 things are what you should do to maximize the chances of financial success in your marriage, but marriage is far more than a simple economic partnership - never forget this as you embark on what should hopefully be the most rewarding partnership with another human being of your life. Marriage is a complicated thing that is at once a legal, spiritual, and historic proposition with many traditions and historical aspects mixed in even in our modern Western society.
Pennies and Pounds wishes you and your future spouse the best of luck as you embark on this journey and we are thankful that we had an opportunity to contribute to your marital happiness and prosperity in some small way.
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Saving money is the first step to financial freedom and wealth, but it is usually not enough. Simply saving money will force your entire financial plan to rely on your ability to earn and save. Investing the money you saved, however, will create a situation where you money could potentially work as hard as you do - earning every single year and compounding those earnings in order to earn more and more in subsequent years. Read the piece below to get a good grasp on why you likely must invest your savings.
Saving vs. Investing
Saving money is not the same as investing money. Although to invest money, you must first save it, saving and investing are two very separate things.
First you must earn an income. You can earn an income by selling your hourly labor or you might earn an income in other ways (eg. investment income, residual income from intellectual property, etc.). Regardless of how you earn an income, you must decide what to do with the money that is coming in. A prudent person will never spend his or her entire income - they will instead make sure to live below their means in order to be able to save a portion (hopefully a substantial portion) of their income for various things:
an emergency fund for financial emergencies
a cash reserve for expenses that don’t occur monthly (eg. once a year, once a month, once in a lifetime)
investing money in order to grow it - this is where most of your money will go
You save money in order to invest, but just because you save money doesn’t mean you are investing it or that you’re an investor. Investing money is a very specific action that you take with your money in order to grow it in a calculated way. Read our article on what constitutes proper investing to get a good understanding what investing really is:
Are you investing or speculating? (The Real Definition of Investing)
If you put money into your checking account, into your savings account, under your mattress, or in your backyard, you are not investing it - you are merely saving it. Even though a savings account pays you a rate of interest, it doesn’t qualify as proper investing because the rate of return is certain at the outset and because the goal of such a product isn’t to grow your money but to keep it safe. Additionally, this will almost never outpace inflation - you'll lose purchasing power every year on average. For more, read the article above on what constitutes proper investing.
So, why do we have to invest?
You must invest because saving is not enough - if you are a salary earner or a small business owner or self-employed (if you’re never going to strike it rich but instead rely on a monthly income), you will never become very wealthy by just saving money every month unless your income is incredibly high. You must invest because of simple mathematics - because the numbers don’t make sense otherwise.
A Simple Example of the Power of Prudent Investing
Let’s imagine two households: Household A and Household B. Each of our households earns a decent income although Household A earns more. Both of our households are hard-working and both have goals for the future - they both want a nice nest egg to retire on and to enjoy.
So, we see that Household A and Household B end up with about the same amount of money in 30 years but had vastly different approaches - Household A just saved money while Household B not only saved, but also invested.
The reason Household B did comparatively better than Household A (it saved almost 10 times less per year but achieved the same results) was because Household B worked for its money and then it put that money to work - Household A just worked for its money.
Work for Your Money - Then Have Your Money Work for You
Investing allows your money to work hard - investing allows your money to grow and compound. By just saving your money and not putting it into ventures or schemes that will allow it to grow, you are relying only on your hard work to get you to your financial goals. Financially wealthy and wise people, however, realize the power of money - they see its power to earn a return and to allow that return to compound over time. The compounding that occurs over time is like a snowball rolling downhill, picking up ever-increasingly large amounts of snow as it continues.
1. Saving alone isn’t usually enough to reach your financial goals unless your income is sufficiently high and you have the willingness and ability to save very large amounts of money (to sacrifice a lot) - investing is a much easier and much more effective strategy for building wealth.
2. The advantage of investing is simple - with investing your money works for you. With saving only, however, your entire nest egg is dependent on your ability to save. By investing, you are allowing your money to earn a return and the compounding of that return beautifully increases your wealth over time.
Every journey begins with a single step. Have you heard of that saying? You’ve probably heard of it and although it might sound cliche, it is extremely insightful. If you don’t have at least $1000 put away you have not taken your first step on the path to financial freedom - it’s time to take it with the help of Pennies and Pounds in this in-depth guide. The first step on your path to financial freedom and wealth is putting $1000 away as a starter emergency fund - that fund will stand between you and the financial emergencies that will come your way in the future. Without even $1000 saved, you are exposed to extreme risk because even a slight financial emergency has the potential to wipe you out financially or put you into debt. Read the piece below for a comprehensive guide on getting to your first $1000 and you’ll be well on your way to financial success and financial freedom.
Don’t Have $1000? You’re in a dangerous situation!
Whether you are 18 or 80, if you don’t even have $1000 in your pocket in the developed world, you’re in a dangerous situation and you must immediately do the things below to build up at least a basic $1000 rainy day fund.
A rainy day fund or an emergency fund is a required part for most financial plans because it protects you in various ways. You can read more about why you need an emergency fund in this very comprehensive article that will surely make you look at your finical life in a different way (check this article our immediately after reading this article):
Why You Need an Emergency Fund: The Most Complete Explanation Ever
However, if you don’t even have $1000 saved, we can’t yet be concerned with a real emergency fund because you don’t even have a tiny buffer between you and life’s uncertainties and financial storms. An emergency fund will almost always be more than $1000 if you’re an adult with living expenses (and will definitely be more than $1000 if you are running a household), but we must take the first small step, moving you from the absolute nakedness of not even having $1000 saved to putting a $1000 financial blanket over you.
Without any money saved in a rainy day fund or emergency fund, you will have trouble handling the following possible financial emergencies:
Additionally, without even a bare minimum of $1000 saved, you will likely find it very difficult and stressful to deal with expenses that aren’t emergencies, but that are rare (eg. those that occur once every few months, once every few years, etc.) - expenses such as:
If you don’t have $1000 saved, you probably know the above already and you probably already know how stressful life can be without some sort of financial cushion, but we must reiterate it in order to really demonstrate how important it is that you act now and act quickly to put $1000 away.
Once you have your $1000 saved, you will feel much better. Although $1000 isn’t a proper emergency fund for most people, you’ll still have some breathing room in your life once you are able to put away your first $1000 - you’ll have some cash put aside for when life comes knocking on the door. You’ll know that you can handle small financial emergencies easily because you have the money put aside for them. You’ll also feel proud for doing it because getting to your first $1000 (regardless of your age) isn’t an easy task. If you can get to $1000, you can move forward to building up a full emergency fund and then building some wealth for you and your family.
Why don’t you have $1000 already?
If you don’t have $1000 put away already, it’s likely for one of the following three reasons:
First, let’s address the third category - if you recently dealt with a financial emergency that wiped you out financially. That’s a very tough situation to be in. However, if you had an emergency fund before the financial emergency and if you had some wealth built up, you actually did pretty well. Yes, you’re back at square one now, but you have proven yourself capable of building an emergency fund and building wealth. So, you can do it again, even though it may seem incredibly hard now. In a way, we’re not as worried about you as we are with those in the first two categories. So, ask yourself whether or not you were doing well once financially and whether or not your current situation is just because of some finical emergency. If that’s the case, get back up, look into getting some more insurance in place to guard you in the future, and begin anew, with the knowledge that you’re capable of doing what’s right for your finical life. There’s deep dignity in being able to take a hard punch to the chin and having the grit to get back up again - have the grit and get up.
Now, on to the first two categories - these are serious issues because they demonstrate fundamental or structural problems with your finical life - it’s not that you had a run of bad luck. If you’re in the first two categories, some drastic but focused changes will need to be made so that you can get on the right track finically and put some money aside for yourself and your family.
1. Don’t Make Enough Money
This is tough and everyone should understand this. After the Great Recession, the US economy (and generally speaking, the global economy) has recovered, but it has been an unusual recovery compared with other economic recoveries in the last century - it has been a recovery in the stock market and the GDP, but not in employment. Yes, the unemployment rate has dropped, but the definition of the term “unemployment” is very precise and that precision can be misleading when people exit the workforce. We won’t go into the details of how unemployment is measured or the technical definition of the unemployment rate in this article, but it is important to note that just because the unemployment rate has gone down doesn’t mean that things have gotten much better in terms of employment - people might be employed but underemployed and some people might have dropped out of the labor force altogether (and, therefore, wouldn’t be counted as unemployed per the current definition of unemployment in the United States). Those are a lot of words to explain what you probably already know, just because you have a job doesn’t mean it pays enough and doesn’t mean you have enough hours at it to make a good income.
If you don’t have an income at all currently and are on your own (if you’re pursuing some sort of education and are living with parents or other relatives you’re not really on your own yet) then you’ve got a bigger problem than those that are underemployed - you’re not even earning anything. That’s an understandable position to be in - the economy of the United States and much of the Western World has shifted and is continuing to shift towards a more capital-intense knowledge-powered economy that is making many people simply unemployable. What this means is that many people aren’t unemployed because they are lazy or don’t apply for jobs or because they somehow failed to get the right skills - it’s that we’re transitioning towards an economy where there are no right skills for you to have, an economy where not everyone can have a job because there just aren’t that many jobs available. Now, we know it’s a tough situation for many people, but that can’t stop you from doing your best to earn some sort of income and putting some money aside for the future. You cannot afford to be left in the backwash of the transitioning global economy - you must find the energy to do something today to move forward while at the same time creating a gameplan for the future.
Whether you are underemployed or unemployed, you should likely get working right now in some part-time job or freelance gig. The job doesn’t have to be something you see yourself doing one year from now, it just has to be something that can reliably bring in extra cash every week and every month, allowing you to put some money aside to get you to your first $1000.
A Few Potential Side Gigs
Pizza Delivery: This is a slightly old-school recommendation for a part time gig but it can still work in the right situations and for the right people. It doesn’t pay very well hourly, but you have the potential to earn a decent amount in tips if you work in a good area and are personable.
Drive for Uber or Lyft: This seems like the 21st-century version of the pizza delivery job. It’s becoming common knowledge that Uber, Lyft, and other firms are attempting to move away from human-based transportation, so the opportunity to earn money with Uber and Lyft might not exist a decade from now, but you can definitely take advantage of it today as long as your car meets their requirements.
Cashier: This works best for seasonal work - times of the year (usually the holidays) when business picks up and extra workers are temporarily needed. There are a few disadvantages with this type of job, however. You can’t set your own ours and you can’t work extra hours. Freelancing or driving for Uber, for example, you can decide to have an intense two weeks and drive a lot of hours to earn some extra cash quickly - with a typical cashier (or similar) job you just can’t do that and you’ll have to be ok with the money trickling in slowly. Additionally, the pay is likely to be low with few or no opportunities to earn tips.
Upwork: If you have some advanced and in-demand skills, check out Upwork, an excellent way to freelance online. It might take some time to build up your profile so you’ll have to be a bit patient compared to other jobs (you don’t start earning much immediately) but you have the potential to earn a very good hourly wage and you can work from anywhere.
Fiverr: Similar to Upwork, but paying less, Fiverr allows you to freelance and take jobs from anywhere if you have in-demand skills.
If you can get a side job (or two - and possibly three), even temporarily, you should be able to put enough money away every week or every month to build up your first small rainy day fund of $1000. If you’re in this camp, however, you need to make sure to stay vigilant and forward-looking because you don’t want to:
The ideal situation is you working now and putting money aside while developing some sort of gameplan to earn more in the future - earn more not just by working more hours but by earning a higher hourly wage. To earn more per hour, you’ll need to improve yourself - you’ll need to improve your technical or job-related skills, your professional skills, and your overall personality. Think about where you want to be in a year and in a few years and move in that direction, getting the necessary skills and experiences so that you can end up in the job you want (and can realistically obtain).
2. Earning a Decent Income but Spending Too Much
If you’re in the camp of people who earn a decent income but who overspend, you’re in the toughest camp because some deep changes will need to be made in order to make financial progress - changes that might take less time than a side job but that are more mentally and spiritually difficult to accomplish and changes that you’ll have to stick with for the long run if you are to permanently improve your financial situation.
What’s a decent income?
Now, by decent income, we don’t mean earning six figures or earning enough money that all financial irresponsibility will be wiped away just by the sheer volume of money coming in. By decent income, we mean an income that is around the median income of your community or state. There is no hard and fast rule for this, but you could consider earning anywhere from 75% of your community’s median income as a decent income that should easily allow you to put away $1000. If your household makes a median income, in the vast majority of cases you should easily be able to have $1000 put away - if you don’t seem to ever be able to do this then it means you are likely consistently overspending and living beyond your means even though your means allow you to live a reasonably comfortable life while still saving for your future and building your financial house.
Read this excellent Wikipedia article that lists the median household incomes for every state in the United States
You Must Cut Out Unnecessary Spending in Order to Save Money
If you’re making a reasonable income and you still don’t have $1000 saved, you must likely cut down on your spending. It’s very difficult to write general statements for a general audience, but it is likely that most readers who earn an income 75% of the median in their communities (or more) and are unable to put away $1000 likely have a problem with overspending and understanding the difference between necessities and luxuries.
It is very difficult to move from a lifestyle of reckless wastefulness to lifestyle of frugality and discipline. Many people try for a little while but then return to their old ways of overspending. It seems that there are underlying reasons for many people’s dysfunctional financial habits that cause them to behave in irrational and self-destructive ways. We won’t go into them here in any depth, but here are a few possible psychological issues or neuroses that potentially cause people to behave recklessly with their money (and overspending is definitely reckless financial behavior):
Now, we all feel bad about ourselves at times. We all doubt ourselves at times. We all have occasional fears of being in poverty and many people have been spoiled in certain ways. However, many of these people are still able to live financially responsible lives because they do not allow their internal psychological issues and neuroses to influence their pocketbooks, their bank accounts, and their wealth building programs - they understand that the cost is just too great and that nothing will be improved by mishandling finances. However, handling your finances properly and spending less then you make (living in financial dignity) will allow you to improve both your financial life, your personal life, your professional life, and your internal life - it will make you into a happier and stronger individual.
I know the above is easy to say but hard to do - it’s very hard to overcome yourself and stop misbehaving financially. However, if you are to ever build wealth and live a financially stable and successful life you must begin to improve your interactions with money and your ability to handle it properly. You must begin by saving your first $1000 so that you may go on to amass $10,000 and $100,000 and hopefully much more than that in time. But, you’ll never be able to amass any real and lasting wealth if you are governed by your own psychological neuroses and your momentary whims and desires to spend money on frivolous things when you don’t even have $1000 put away for yourself.
To the Details - Start Putting Away Some Money Every Week
If you put in a concentrated effort into building up your wealth, you’ll be able to save your $1000 in less than a year (and possibly in less than 3 months if you can save more).
Don’t save every month - do it every single week. If you attempt to save every month you might end up at the end of the month with not enough to put away. You will run the risk of not having the needed amount if you do it every single month. However, if you save a bit of money every week, it will be both painless and it will assure that you actually are able to put enough money away. Weekly savings will be relatively painless. Weekly saving doesn’t even require receiving a weekly income - you can be paid biweekly or once a month and still successfully save every week because you can save a very small amount every week (an amount possibly less than the cost of a single skipped restaurant meal).
Take a look at the graph below to see how long it will take you to reach $1000 by saving either $25 per week, $50 per week, $75 per week, or $100 per week. Obviously saving more is better, but even if you can put away $25 a month, you will have your $1000 in less than one year - you will transform your financial house from a desolate and empty lot to a lot with a slowly building solid foundation (a foundation on which you will continue to build upon).
Additionally, you will want to create a monthly budget. This is tough and you can expect that you’ll be way off on your budget for the first couple of months, but things should get easier if you keep at it. In creating a budget, plan on where each dollar will go to next month and do your best to stick to it. Next month, before creating another budget, evaluate the success and failures from the previous month. If you’re married or financially intertwined with a partner, make sure to create the budget together. Not both of you have to put in equal effort (some people are more financially savvy or more interested in personal finance than others) but both of you should have a seat at the table and both of you should have a say into how the budget is determined if you are to do this in a proper and overall healthy way.
1. If you don’t have $1000 saved up, you’re in a dangerous situation because you are exposed to both financial emergencies and one-off expenses (those expenses that are not monthly but that instead occur yearly, every few years, or once in a lifetime). Without having even a very basic $1000 rainy day fund, you are in a very precarious situation which will prevent your from building wealth - if you can’t even save $1000, how will you save $10,000 or $100,000 or build lasting wealth. This should motivate you to put in the work and make the necessary sacrifices to get to your first $1000. The good thing is that $1000 isn’t very hard to save up - as the above graph demonstrates, even putting away an extra $25 per week will get you to your $1000 in a lot less than a year.
2. Depending on your current situation (not earning enough vs. big spender), you will have to approach things as described above. Be aware that the problem with your current financial situation isn’t just the numbers, but it is with your heart and your soul also - never forget that who we are inside will manifest itself in our finical life also. Be courageous as you make the necessary external (getting an extra job or building a budget) and internal (understanding why you overspend if you’re in the second category) changes to start on the path to financial success and finical freedom.
If you’ve had a financial emergency that forced you to dip into your emergency fund, rebuilding it quickly is crucial to your financial success even though it might seem like a difficult and unpleasant task. Read the article below to get motivated and to find out how you’ll be able to rebuild your emergency fund very quickly.
If you have weathered a financial emergency by tapping into your emergency fund, I want to take a moment to congratulate you. I know things might seem difficult now and even if the financial emergency is gone, it never feels good to have to tap into your emergency fund. However, I congratulate you anyway because the fact that you even had a rainy day fund in place puts you above so many others who must weather financial emergencies with no rainy day fund - they must either resort to going into debt to pay for the financial emergency or they must liquidate some of their investments. You, however, planned ahead and had a rainy day fund in place to guard you and your household against life’s financial storms - instead of hoping that those storms wouldn’t come, you knew they would one day arrive and you set out to put an emergency fund in place between you and the harsh realities of the world.
Now, however, it is time to once again buckle down and quickly rebuild your emergency fund. You can’t waste time by slowly rebuilding your emergency fund. At Pennies and Pounds we recommend building up your emergency fund very quickly and, in the same light, we recommend rebuilding your emergency fund very quickly after a financial emergency.
First, You Need to Get Motivated
Don’t Have the Energy to Do It Again?
I know how hard it is to weather a financial emergency and to see the emergency fund you built with your sweat, your toil, and your sacrifices be depleted to take care of something that shouldn’t have even happened in the first place. You might not feel that you have the internal energy to build up your emergency fund quickly again - you might feel like you’re not up for it. This is an understandable feeling, but you cannot let it prevent you from putting in the necessary effort into rebuilding your rainy day fund quickly, an integral part of your financial success and well-being.
It’s Not as Hard as It Might Seem
The truth is that even if you feel like it’s too much trouble to rebuild your emergency fund, you’re probably wrong. It’s not as hard as you likely think it is. You built up your rainy day fund once and you can do it again. In fact, it will be easier to do it again because you’ve already done it once before - you have proven yourself capable of achieving the important task of putting a proper emergency fund in place.
Building up your emergency fund won’t take much time, but it will take some concentrated effort. The good news is that the effort you will have to exert isn’t particularly difficult as you will see below - it might be slightly physically taxing, but it won’t likely be overly mentally or emotionally taxing. You’ll need to buckle down for a bit, but it won’t be long or particularly arduous.
Use the Following Strategies to Quickly Rebuild Your Emergency Fund After a Financial Emergency
The recommendations below are exactly the same as those given in our article on how to initially build up your emergency fund quickly. They work in this situation just as well.
1. Get a Temporary Second Job
Get a second job doing something on the side. Dave Ramsey's pizza delivery job has been the classic recommendation, but today many more options are available. You can drive for Uber or Lyft if your car meets the requirements. You can tutor if you have skills that are in demand. If you have the skills, it might be possible to do some freelance consulting. Even a weekend job as a cashier is a decent short-term gig if it helps you supercharge your emergency fund savings.
2. Sell Stuff
Selling stuff is a tried and true way of getting your hands on some cash quickly. Some people have more to sell than others, but if you have things that you aren't using anymore, try to put them on eBay or Craigslist.
3. Cut Down Big Time
Most households have some fluff-room (that's not a technical term). What I mean is that most households aren't just buying the basic necessities, but are instead buying extra luxuries. It might be possible to buckle down and cut out a lot of unnecessary (although pleasant) expenses for a short while. It obviously won't feel great while you're doing it, but it's not for long and once you have your emergency fund in place you can go back to a normal lifestyle secure in the knowledge that you have a cushion of cash in place against all of life's crazy unpredictabilities.
Using the above strategies, you can quickly rebuild your emergency fund after a financial emergency. We highly recommend you rebuild your rainy day fund as quickly as possible so you can sleep easier and so you can return to focusing on your other long-term financial goals such as investing for the future and building wealth.
1. Even though it might be hard to rebuild your emergency fund after a financial emergency, it is a necessary action and you must do it in order maintain your financial house - in order to keep a buffer between your household and the financial storms that might come your way again.
2. Now that you’ve already had a rainy day fund and weathered a financial storm, it will be easier to rebuild it than you think - you’ve just got to start and you’ll see how quickly you can rebuild your emergency fund using the tried and true tactics above.
To be successful and to live a life of dignity and self-respect, every independent adult who is of sound mind must live below his or her means. Living above your means is just unsustainable. Living at your means might work, but it isn't enough.
You Cannot Reliably and Reasonably Build Wealth If You Are Not Able to Live Below Your Means
Assuming you are not set to inherit a large sum of money and that you won’t have a large and unexpected windfall such as winning the lottery, to truly have a stable financial life and to build wealth, you must live below your means. In fact, even if you do inherit a lot of money or win the lottery or have some other financial windfall, you must still live below your means if you are to maintain and grow your newfound wealth.
The principle of living below your means is a fundamental principle of personal finance and wealth building - it lies at the bedrock of your financial future and without the ability to live below your income (be it earned income, investment income, royalties, dividends, or any other sort of income), you will never become rich.
There is a quote that is relevant here from the book The Richest Man in Babylon - “a part of all you earn is yours to keep.” That quote is deeply fundamental to building wealth and every person who has accumulated riches throughout history has understood the principle the quote is elegantly trying to convey. What that quote means is that when you earn some money, you shouldn’t give it away to everyone else - don’t give it all away to your supermarket, to Apple, to Samsung, to Microsoft, to AT&T, to Verizon, to Comcast, to T-Mobile, to Netflix, to your favorite stores at the mall, to Amazon, to your favorite restaurants, to Starbucks, to your mortgage company, to your car company, to American Express, to Visa, to MasterCard, to Discover, and to all of the other people and businesses who work tirelessly to get some of your hard-earned money (and even if your money wasn’t hard-earned, you still shouldn’t give it all away). If you give all of your money away, you will have none for yourself. And if you have none for yourself, how can you become wealthy over time?
This concept from The Richest Man in Babylon is deeper than you think. I understood it right away when I first read the book at the age of 18, but when I told people in my family and some of my friends about this concept that I found so intriguing, they were puzzled. I got two types of reactions:
They either thought it was too simple of a concept to be intrigued by. “Of course, you should save,” they would say to me. I realized these people didn’t fully understand how profound this concept was, even though they were probably on the right track.
Others, however, were far more deluded. They thought that it was a ridiculous notion because whether they had money left over for themselves wasn’t in their immediate control. They said they had to make credit card payment, mortgage payments, car payments, insurance payments, purchase food, purchase water, purchase clothes, and do all of the other things needed to live a decent life. They argued that it was naive to think that they could magically have money for themselves - naive that they could magically save money every month.
I understand both perspectives, but I know they are both confused and deluded. I also believe that purely explaining it won’t work - one has to actually take the effort and put some money aside one month and see what happens.
It will provide you with dignity
A wise man once said that “there is no greater dignity than living below your means.” This is very true. Humans need dignity and self-respect. As adults we have a deep desire to find our own way, to pay our own way, and to earn our own way. We don’t want to depend on the assistance of others or the assistance of the government (which is the same as the assistance of others).
Of course, I don’t suggest that assistance to those who are in difficult times should not be given. Nor do I suggest that those who are in difficult financial times should feel even a little bit unpleasant or ashamed by receiving help - we are all brothers and sisters on the Earth. However, I do have a basic understanding of human nature and I know that no matter what, an adult wants to be self-sufficient and make their own way.
I believe a part of the reason we want to make our own incomes and make our own way has to do with our ancestral past. Living in small communities in antiquity, everyone had to contribute or else the entire community would suffer. We have a desire to please others, to create value for the world, and do something good for our fellow brothers and sisters. This value creation is rewarded financially (although only usually and imperfectly).
Additionally, the knowledge that you are able to live below your means will give you dignity and self-respect because you will know you are a disciplined person who is able to steer the course of his or her own ship instead of being blown from place to place by the wind. By living below your means, you will have the knowledge that you can make it, that tomorrow will be ok, and that you don’t need to depend on others to survive or thrive (again, not that there is something wrong with depending on others for brief or long periods of time). By living below your means, you will have the comfort knowing that there is robustness in your life - that you are a resilient person who can thrive even in the face of difficult times and uncertainty. A person who consistently overspends is a person who lacks disciple and who cannot be confident in his or her ability to whether life storms well - that person will wonder about what will happen should things get worse. Instead, we must strive to live life well, but in a manner that reflects our understanding of financial principles, our disciple, our courage, and our resilience.
"A part of all you earn is yours to keep."
Today, if you live in the developed world, you have an unprecedented financial flexibility that will allow you to get your hands on cash very quickly - unlike most of human history. So, do you still need a rainy day fund in the 21st century when you can just use a credit card or sell your investments easily? The answer is YES - read the piece below to understand both sides of the argument and to find out why you still need an emergency fund even in today's modern financial landscape.
Can you not have an emergency fund in place and still be in excellent financial shape? That’s a tough question because a rainy day fund lies at the bedrock of a good financial house and is recommended by most in the financial media and by most financial advisors. However, some say that an emergency fund is an outdated concept in today’s world of very liquid assets and easy access to credit - they argue that you can be in great financial shape without allocating some of your net worth into an emergency fund held in cash. Instead, they would argue, you can have the money you would have allocated to your rainy day fund invested in the market where it would earn a higher return. Are they correct or are is an emergency a timeless piece in your financial puzzle and still required even today?
First, we’ll begin with the argument that AGAINST an emergency fund today…
The World Used To Be Different
Let’s go back 100 years into the past and look at an average middle-class person’s financial house. That person likely had:
So, 100 years ago, and basically any time in human history, your financial situation was a lot less complicated and much less flexible. You would find it difficult to finance a semi-major purchase. Additionally, if you needed money quickly to pay for some sort of financial emergency, you wouldn’t easily and quickly be able to obtain it.
Today There's Much More Financial Flexibility
Today, those in first world countries live in a world filled with more financial options than was ever available. Today we have:
So, do you really need a rainy day fund when you have all of the above options to handle financial emergencies?
Yes - you still need an emergency fund in the 21st century. Although we live in the world with much greater financial flexibility and with a bigger societal safety net, you should still have a 3-month to 6-month emergency fund in place to protect you. It is the case that if you didn't have a rainy day fund today, you would likely fare better in a financial emergency than you would 100 years ago, but that isn't relevant. An emergency fund will still protect your financial well-being by allowing you to weather financial emergencies:
Additionally, a rainy day fund will keep you calm - it will help you sleep better at night. Regardless of the financial innovations that now allow you to have much greater financial flexibility, an emergency fund is still a crucial part of your financial house.
Further Reading: The Most Complete Explanation Ever on Why You Need an Emergency Fund
You know you need an emergency fund in place, but do you know why? All of the financial media says you should have a rainy day fund in place, but few discuss the reasons for such a recommendation. It might seem obvious, but it's a pretty interesting discussion. Read the article below for a very in-depth analysis on why you should have a proper rainy day fund in place and you'll likely know much more than most on this often-overlooked topic.
Does anyone in the financial media or the financial press even address the question of why we need an emergency or rainy day fund? I feel that the idea of having an emergency fund is so deeply ingrained in the personal finance world that no one in personal finance discusses why you actually need an emergency fund. I don't think that's wise. If we are going to save up 3-months to 6-months in living expenses (a serious pile of cash), we better have a good reason for it. Otherwise, why bother with it? We could either spend that money on things we enjoy, give it away to someone in need, or invest it in the markets where the money has a chance of obtaining a return and growing. Why would I just have a pile of cash sitting around earning abysmally low rates or return if there isn't a solid foundation to it?
First, let's define a term - Stochastic
Something is said to be stochastic in nature when it is randomly determined or when it's probability distribution cannot be precisely predicted.
Stochastic is sort of the same as random. So we can say, "this is a stochastic process" or "these events are stochastic."
Here are a few examples of stochastic processes or things that have stochastic components to them:
The term stochastic is heavily used in mathematics, but we don't need to give the term any more treatment than we have already. I didn't use the word "random" because I wanted to really bring home the fact that the physical and life sciences, mathematics, and even the social sciences recognize the fact that the world is random and unpredictable in many ways. For many things that have a material effect on our lives, it might be possible to understand the general distribution of things (eg. what will happen on average) but it is not possible to understand what will happen next.
The World is Stochastic in Nature
As stated above, the world is stochastic in many ways. The world is filled with randomness and random processes and occurrences. There's no way to tell exactly when your car will break down, when a major weather event will require a window replacement, or when your body will have some sort of medical emergency. There's not a way to predict when you'll get into a car accident, trip while walking off a curb, or when the economy will fall into a recession and you will lose your job. Hopefully, none of the above ever happens to any of us, but there's no guarantee. And so, we must be prepared as best as we can.
One way we can be prepared for possible emergencies is to be financially prepared. We can be physically prepared, mentally prepared, emotionally prepared, and spiritually prepared, but we must also strive to be financially prepared to weather life's inevitable blows to our peace and tranquility.
Now that we understand that the world is random, we can see that this randomness might cause financial emergencies - things we weren't anticipating that require the use of money.
How can we react to such financial emergencies? There are 4 main ways you can react to a financial emergency:
4 Ways to Handle an Emergency
1. Sell Your Investments
One way to handle a financial emergency is to sell your investments (if you have them,). If you're invested in the stock market, for example, you can liquidate enough shares to take care of the financial emergency. That's easy, right? Wrong.
If your emergency occurs after at the end of a long bull run, then that selling your investments to pay for your financial emergency could possibly be a reasonable idea. But what if your financial emergency occurs during a recession? Isn't it more likely that a financial emergency such as losing your job will occur during a downtrend in the stock market. What if there is no recession or downtrend, but your particular portfolio is down? Selling your shares to cover the financial emergency will be very unpleasant and it will further compound the already bad situation. You'll basically be locking in the losses and losing an opportunity for a possible recovery. You want to have the opportunity to ride out the downtrend should you so desire.
The example with stocks can be extended to investments in commodities, real estate, bonds, and derivatives. You don't want to have to sell when things are down. You want the flexibility to be able to stay invested and ride things out.
2. Cash Flow Through the Emergency
Not everyone has investments and even if they do, they might not have enough invested to cover a financial emergency. So, if you can't sell investments to pay for it, maybe you can just cash flow through the financial emergency - maybe you can just pay for things with the income you have coming in every month. But what if your emergency is such that your ability to earn an income is diminished or eliminated for a period of time? What if you just don't make enough to cash flow through your financial emergency?
It's pretty risky to rely on your ability to earn your way through an emergency. Say you need a car repair that costs $500? You can cash flow through that relatively easily. But what if you have a medical emergency with a high deductible? That's more difficult. What if you have a major repair that needs to be done to your house? That's pretty difficult too.
3. Go Into Debt to Pay for the Emergency
If you have no investments to sell and you can't cash flow through the financial emergency, you'll probably have to go into debt to take care of things. That's obviously a bad situation. You're again compounding the bad stuff by going into debt.
But what if you can't go into debt? What if you don't have enough on your credit cards? What if you can't get a loan? Now you're totally stuck aren't you? No money and no ability to obtain funds elsewhere will mean you'll have to resort to asking your friends and family for assistance or for loans, a pretty unattractive proposition.
So, the above three options for dealing with a rainy day are obviously not optimal. There's a fourth option: have a rainy day fund.
4. Use your Emergency Fund
It should be obvious by now that an emergency fund is the optimal way to deal with life's financial emergencies. It's better than having to sell your investments to deal with a financial emergency because the emergency fund acts as an insurance policy, protecting you from having to liquidate your investments. If you don't have investments yet (keep reading Pennies and Pounds and you will soon), then the insurance policy allows you to move forward after a financial emergency without going into debt and without stress and anxiety. It allows you to take life's financial blows and get right back up again instead of staying knocked down.
So, we see that random stuff happens and that the best way to protect yourself and your household is to have an emergency fund. An emergency fund will benefit you whether you have lots of investments or no investments at all.
But there's one other reason to have an emergency fund in place...
Not Every Expense is Monthly
Most people think in terms of monthly income and monthly expenses. The more sophisticated or the more financially nerdy among us (myself included) might think about yearly expenses. But there are many expenses in life that are not monthly. Expenses can happen:
Every few years
Every 5-10 years
Only a few times in your life
I hesitated to discuss these expenses in this piece because they aren't proper emergencies in my opinion. Emergencies are surprises that are unforeseen, but the above expenses are not unforeseen - I just wrote about them and named off a bunch of possible expenses that are not monthly. We should plan for them because we can obviously anticipate them, unlike an actual emergency such as a car accident or an injury. So, why did I include them?
I included these expenses because of my awareness of human nature. Humans aren't great at anticipating the future and planning ahead. I know that these expenses aren't proper financial emergencies and I know that we should plan for them, but I also know that we're humans and the reality is that most people will neglect to plan for them. That's just human nature. Studies show that most people fail to even have a basic emergency fund, let alone save for far-off expenses. People have a tendency to focus on the here and now and to not pay attention to what is coming down the road. Therefore, I do believe that an emergency fund can act as a certain protection against our human nature, against our seeming inability to see too far ahead. It acts as a cushion not just against life, but also as a cushion against our own minds and our own selves. If, in a moment of rationality, we can understand this about ourselves (our poor ability to plan for such expenses) we might be able to set up a very strong foundation for our financial security.
An Emergency Fund Just Makes Sense
An emergency fund is important. It just makes good sense. An emergency fund is one of the simplest and most prudent financial moves you can make. Since antiquity, the wise have understood the importance of storing something away for a rainy day.
There is treasure to be desired and oil in the dwelling of the wise; but a foolish man spendeth it up. (Proverbs 21-20)
So, make sure you have a proper emergency fund in place and do the hard work needed to get one set up quickly. You already knew that you need a rainy day fund I'm sure, but now you know why with what is probably a much deep and much more sophisticated understanding than most people have.
P.S. Let's get a bit philosophical - Do emergencies even exist?
I couldn't help getting a bit deeper and philosophical here. Let's think about this. We figured out that life and the world are random and that random and unpredictable (stochastic) stuff will happen. So, are there really any real financial emergencies? By definition, an emergency is something unpredictable. But, although we can't exactly predict when something bad will happen because of the stochastic nature of things, we can definitely be sure that the world is random and that something might happen at any time. So, we should never be really surprised when we have a financial emergency became we should already know that it's a possibility. Regardless, we still need to have a rainy day fund set aside. So maybe there aren't really emergencies after all - maybe there are just those things that we know will happen and those things that could happen but shouldn't surprise us if they do. What do you think about this? I'm interested in your opinion on this - comment below or email
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Once you've accumulated your 3-month to 6-month emergency fund you will need a place to put it. Where should you keep your emergency fund? There are actually 3 places you should keep your emergency fund for optimal protection and efficiency. Read the article below to find out what those places are so you can rest easy knowing you have a solid financial emergency cushion in place.
Rainy Day Fund = Protection Against Life's Financial Storms
Your emergency fund is protection against life's financial uncertainties. The typical rule of thumb says that you should have 3-months to 6-months of living expenses in your emergency fund. That rule of thumb balances the cost of not having money in the markets with the benefit of a rainy day fund provides - namely, insurance against life's financial storms. Of course, some situations vary and might call for a larger emergency fund, but I would caution against going below 3-months of living expenses.
But where do I keep my rainy day fund?
Having 3-months to 6-months in living expenses leads to a further question: where should you keep your rainy day fund? This is an important question because your emergency fund is a significant amount of money and requires prudent care in order to protect it while still having the liquidity a proper emergency fund requires.
Don't Just Keep Your Emergency Fund in One Place
My advice is to keep your emergency fund in more than one place. You want your overall rainy day fund split up into 3 categories:
By keeping it in three places, you are properly protecting yourself against emergencies. Not every emergency happens during bank operating hours and you might not have access to an ATM. You should have a small portion of cash in your pocket and a small portion of cash at home with the rest in a liquid account at a bank (or more than one bank - one a brick and mortar bank and one an online bank for the higher interest rate).
1. Cash in your wallet or purse
Emergencies can happen anywhere. You might have a situation where cold hard cash is required (although that is becoming less and less of a worry as the world digitizes and even small businesses can easily accept credit cards). For those rare or hopefully nonexistent occurrences, having a small percentage of your rainy day fund in your wallet in the form of cold hard hundred dollar bills and twenty dollar bills might prove useful.
You obviously don't want to have a significant amount in your wallet or purse for the obvious reason that it could be stolen or lost. You should be wise and prudent in how you keep this money. Put it in a more secret place in your wallet or purse if such a place exists.
I don't have a hard and fast percentage rule for how much you should keep in your wallet or purse, but it should probably be less than 5% of your total rainy day fund.
2. Cash at home
You want to also have some cash at home. I don't have a hard and fast rule for what percentage of your emergency fund you should keep at home, but it should probably be less than 25% of your total emergency fund.
Keeping cash at home is a good idea for various reasons. First, you might need to get your hands on cash right away without having to make a trip to the bank or an ATM. Additionally, there might be a natural, societal, or political disaster that prevents you from leaving the vicinity of your residence for various reasons (eg. safety, inability to get on roadways, injury, etc.). In this situation, cash at home might prove very useful should there be opportunities to purchase basic necessities within your neighborhood or to transact in other beneficial ways.
3. Money in the bank (or banks)
The majority of your emergency or rainy day fund should obviously be kept in a bank. There the money is physically safe and FDIC insured (assuming you are within FDIC Insurance limits). We now have a few options for exactly how to keep the money in a bank.
Brick and Mortar + Online
You should do both. Keep a portion in your brick and mortar bank for quicker access and keep the rest in an online bank. An online bank has two benefits:
First, it allows you to separate from the money a bit more but still gives you quick access when needed. This separation prevents you from using your rainy day fund for unnecessary things or non-emergencies. The separation gives you a bit more time to think about whether using the money is actually required.
Second, you will most likely get a higher interest rate at an online bank. The purpose of your rainy day fund isn't to obtain a return on your capital (it's to protect your wealth and your other investments from liquidation in a financial emergency), but it doesn't feel pleasant when you're earning abysmally low interest rates. Keeping a portion of your emergency fund in an online bank might remedy this.
Savings > Checking
Keeping the money in a savings account that is linked to your checking account is preferred. The savings account will earn a higher interest rate and it will allow some sort of separation from your daily transactional account. A dedicated savings account (both at your brick and mortar bank and your online bank) is a good idea because you'll know exactly how much money is allocated for your rainy day fund and you won't get it mixed up with your transactional accounts or with other savings accounts (eg. other liquid cash, down payment, imminent tuition payments, etc.).
What if I have more than the FDIC Insurance limits?
If you are in the pleasant situation of having more money in your saving account than is covered by FDIC Insurance limits (currently $250,000 in each bank for individual accounts - visit the FDIC website for the full information on this), you'll want to split up your money and put it into different banks so that you are below the limit at each bank. I would recommend being careful and doing your research with this in order to make sure all of your rainy day fund is covered by FDIC Insurance.
If you have so much money that it is not feasible to put your entire rainy day fund in various banks (eg. an emergency fund in the millions or tens of millions of US dollars), then you might have to purchase less liquid instruments such as US Treasuries in order to keep the remainder of your rainy day fund, but won't go down that path here. However, it is unlikely that your rainy day fund will be that large because your rainy day fund should cover 3-months to 6-months of living expenses, not income. Even if you have a very high income, it is unlikely that 6-months of living expenses will be more than a couple of million dollars.
Further Reading: How big should your emergency fund be?
Further Reading: 3 Ways to Build Up Your Emergency Fund Super Fast
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