First, let's agree it's a good goal to have some money saved up. Having money in reserve can help you avoid one of life's biggest pitfalls: accumulating debt. When the car breaks down or the dentist gives you bad news, your ability to pay the bill out of savings—instead of putting it on a credit card—is huge. Knowing you have a reserve you can count on also provides a tremendous amount of psychological security: You don't go through your week afraid of what will happen if the unexpected hits.
So how much should you save? The answer varies, but I like to start with an amount equivalent to three months of your current monthly spending. This should increase to six months if you can afford it, and it should definitely increase the more variable your income stream is. If your income rises and falls, you should target a larger amount because you'll need cash available for those down months.
The next step is figuring out your spending. Start by looking at your bank statement at the end of the month and adding up the cash withdrawals, automatic payments, and checks written. (And please tell me you have a bank account, not a drawer with crumpled bills under your T-shirts, or else we have a lot more work to do.) If you want to get more precise, go to my website (www.davidcolley.wrfa.com) and look at the cash-flow-analysis calculator there. It will give you a more specific number to use.
So now you have the goal clearly in mind. Let's say your monthly spending is $5,000. Then you need a cash reserve of $15,000. How in the world are you going to save up that much? Unfortunately, there's no trick. If that big job comes in, take that 10 percent as a start.
But for most people, it's more like losing weight: You just have to make yourself do it. You'll see a little progress week by week. If you can save $144.23 per week, you'll have $15,000 in two years. Now, that may sound aggressive to you, or it may sound very possible. I recommend starting with an amount you feel is doable, one you can stick with. Clients who begin with too big a number often fail because they feel punished or discouraged and quit. Start with a lower number, and once you realize you can live without it, raise it a bit in six months.
But the only way this works is if you pay yourself first. That means don't wait until the end of the month to come up with the cash; do it early in the month, before you get a chance to spend it. If you get paid on the fifth of the month, set up an automatic transfer from your checking account to your savings account on the seventh, so you know the savings will happen. Otherwise, the odds of success can go way down.
And this money doesn't have to be invested in anything more complicated than a savings account at your bank. The job of this account is to be there, safe and sound, when you need to access it, not to grow at 15 percent for your retirement. We'll leave that strategy for another day.
So pay yourself first. You'll sleep better knowing you did.
The opinions expressed are those of David R. Colley and are meant to be general in nature and should not be construed as investment or financial advice related to your personal situation. Please consult your financial adviser prior to making financial decisions. Colley is a financial adviser with Waddell & Reed, member SIPC, and can be reached at (310) 371-7036.