#948 Calculate Six Months To Adjust to New Financial Circumstances

4 Jan

Cutting expenses takes a bit of habit adjustment in practice. All photo via flickr by Images_of_Money.

Cutting expenses takes a bit of habit adjustment in practice. All photo via flickr by Images_of_Money.

Forget three months of emergency savings…you need six months. Not only does it give you a bigger cushion, but I’ve found it takes about six months to adjust to a new financial reality. You might know your finances have changed. You might have reconfigured your budget. You might of spent hours with your sweaty fingers clutched to a calculator. But even then, what you know and what your brain and body want to do are two different things. Your behavior doesn’t usually do an about face overnight. Ingrained habits and the myriad of daily tasks that you do almost unconsciously don’t adjust as quickly as the cash flow stopped. Whether it was planned or unplanned.

Don’t you hate it when you switch the silverware drawer, and you spend the next few weeks opening the old drawer expecting to find spoons when instead you find dishtowels? Even months later, you may occasionally open that drawer expecting to find the pie server. It’s the same thing with spending and money habits. At first you still expect to do the same things, when things aren’t the same anymore. And slowly, you adjust. Month by month, your financial habits and brain become reconfigured to the new way of doing things. That’s of course, if your conscious of what a new financial reality means. If you’re in denial and never change, then you’re one of those people written up in the news who used to have six-figure salaries and still have a maid, a nanny and a lawn guy even though they’ve been unemployed for a year. So don’t be those people.

Put money in the bank for six months of living expenses.

Put money in the bank for six months of living expenses.

If something in your life happens that affects your income like losing your job, moving to a single income from a double income or long-term illness, be prepared with six months reserve cash to cover your expenses while you recover. Six months will give you time to find another job or launch a new career. You’ll barely get a job interview in three months. Six months will allow you to embrace your new financial outlook. Three months will leave you in a panic that you didn’t cancel the cable bill as soon as you lost your job.

Six months will allow you to enjoy your switch to being a stay-at-home mom or dad while learning what one income instead of two really means in practice. Three months will barely have your kid sleeping through the night while you’re up anyways worried about money.

Six months will allow you to get answers about your illness and a treatment plan so you can return to work or make other plans. Three months will leave you stressed, which is not good for healing.

Bottom line: six months reserve cash for life events that affect your income. And six months for your brain to reconfigure habits to fit into the new financial circumstances. By the end of six months, you’ll have gotten so good at the new financial model, that even if you do go back to work or get a new job, you can save more money and use your cash more wisely because you’ve gotten used to the adjustments. You probably won’t even notice them anymore, but your bank account will.

Having a planned income change is easier to plan for ahead of time. Start earlier than you need to.

Having a planned income change is easier to plan for ahead of time. Start earlier than you need to.

If the new financial reality is planned, like staying at home after the birth of your child or launching a business, then you can plan even more precisely and practice the money saving measures ahead of time. Why wait for your baby to be born or for your business to be launched to reconfigure your budget? Start living like you’re on one income once you’ve passed the 12-week mark of pregnancy. Start living like you are all-in on your business (a.k.a. a poor entrepreneur) six months to a year before you quit your 9-5 job. That way when the baby comes or the paychecks stop being regular, your confident instead of in a panic.

Saving for six-months of expenses is a big chunk of money. You should have a line item in your budget for it. Take the bare minimum of what you will have to pay: rent or mortgage, utility bills, outstanding debt (pay at least the interest), food, transportation, insurance and childcare (if needed). This will provide you with the basic needs of food and shelter and the ability to continue working or to find work. It will cut out all “superfluous” expenses, which would greatly increase how much you need to save. Add it up and save for that amount while working on alternatives to save money so that you may even spend less than your six months of savings in six months.

Calculate expenses to cover basic needs like food and shelter.

Calculate expenses to cover basic needs like food and shelter.

Six month estimate for a couple with a child living in a house (changes based on geographic location):
Rent/mortgage: $1,300
Utility bills: $350 (electric, gas, phone, heat)
Outstanding debt: $100
Food: $400
Transportation: $200 (gas, maintenance, bus/subway passes)
Insurance: $100
Childcare: $800
Total per month: $3,250
Total for six months: $19,500
Save $500 per month ($250 per working adult): 39 months of savings for six months of emergency cash or just over three years.

Not bad…better than going $19,500 into debt if you are caught unawares. You should keep the money in an account that earns some interest to keep up with inflation and is low risk, while still having it available at a moment’s notice. Your local credit union would probably have some good options or speak to a financial adviser.

 

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