Understand Your Finances
How to plan—and save—for a financial shock
The thing about a financial shock is that it's shocking. You, or someone in your family, might suddenly lose a job, need a new transmission, or have an accident.
A Pew Charitable Trusts study found that 60 percent of US households surveyed had experienced a financial shock in the previous 12 months. More than half of the households struggled to make ends meet after their most expensive financial shocks.
"It's the same thing as with our health," says Lauren Locker, a certified financial planner. Her New Jersey-based firm, Locker Financial, is focused on helping clients build sound financial plans. "We all know we're supposed to get up and exercise and take care of our eyes and all that. We know we're supposed to do that stuff, and we don't."
Here are some tips on how to plan for a financial shock:
1. Make a budget
You can't know how much you'll need in your reserve fund until you know how much you spend, Locker says. And that means everything you spend.
"Most people say, 'I spend X amount a month,' but sometimes people only look at expenses such as their mortgage, groceries, or their daily coffee," she says.
There are often other expenses throughout the year that don't fit into the monthly budget, such as car insurance payments that come quarterly or big gifts at the holidays. Locker says to factor all of that into your spending tally—and make sure your accounting is based on what you're spending, not what you're earning.
2. Find painless ways to save
To build up that reserve fund, Locker recommends people find ways of redirecting funds they already don't have access to, rather than trying to divert even more money. "You only have so much money," she says. "It's not going to come from someplace magically. So you have to take it from somewhere and put it in another spot."
If you're putting money into a 401(k), divert some of that savings instead into your reserve fund. "For just one year, drop yourself from 15 percent to 12 percent, and put that 3 percent into savings," she says. If you get a raise, put the additional monthly income into the reserve account, before you get used to spending it.
"It's a planning process," Locker says. "It's going to get you into a good habit of doing things one at a time, taking the time to get it done, realizing that this is a building process. Most people, when they see that money growing, that gives them a bit of excitement."
3. Keep your reserve money separate—and use it when you need it
As you build your emergency fund, make sure it's available—but keep it separate. "That money needs to be put in a bank account," Locker says. "Not invested or in a certificate of deposit. It needs to be liquid."
"The greatest trick is having the money directly deposited someplace for you. Don't let it touch your hands or your checking account," she says. She suggests opening up a savings account, and having your bank automatically deposit $50 a month from your earnings into it. Don't link that savings to your checking.
"That'll make you less tempted to spend it, so it'll be there when you really need it," Locker says.
Jesse Oxfeld is a Chase News contributor.