CHAPTER 3: BUY YOUR UMBRELLA
An umbrella is a very useful tool. It folds down for easy storage when not needed. And it can be called upon to open on a moment’s notice when weather conditions require protection from the elements.
The Financial Equivalent
The equivalent to an umbrella in your financial plan is your “Rainy Day Fund”, to maintain the precipitation metaphor. You can find various descriptions and prescriptions for it, but everyone needs a liquid (meaning immediately available) source of funds set aside for covering emergency expenditures. This fund is your self-insurance policy that allows you to stay on-plan whenever the car needs a major repair, or the dishwasher starts to leak or the A/C unit dies in the middle of July.
How Big an Umbrella?
Different experts have different opinions (surprise surprise) but a consensus target size of your Rainy Day Fund is 6 months of regular expenditures. Yes, you read right : 6 months of rent + food + car payment + utilities + everything-else-you-buy that is absolutely necessary to maintain health & safety. Yes, that is a lot of money to have on the sidelines, and a stiff challenge to accumulate for just about anyone less wealthy than Warren Buffett.
A more honest assessment of spending in a prolonged emergency is closer to 60% of normal, so consider adding that waiver to soften your target size of your 6-months expenses goal.
Why So Big an Umbrella?
The “6 Months Expenditures” guideline is really intended to provide the safety net needed to survive a significant and unexpected loss of income (aka losing your job). I will admit, I never was able to accumulate a 6-month stash; 4 was about the best I could do. I also had the good fortune to never lose a job early in life or when our family was young and most vulnerable so I never needed to call on a 6-month reserve. But I know over 40 years our family had dozens of situations where we covered unexpected expenses in the hundred of $'s, and several in the thousands of $’s, with our Rainy Day Fund.
How to Manage Your Umbrella
If you arrived at Chapter 3 via the road through Chapters 1 and 2, then you have acquired knowledge of your finances (aka lived your budget) and control over your finances (eliminated credit card debt). With this power you are now ready to create your Rainy Day Fund. If you are saving 5% after-tax and applying the 60% correction to expenses to cover, you can accumulate 1 month’s expenses in 11-12 months. If you can achieve a 10% savings rate, then you just halved the time to 5-6 months. Continue until you accumulate the number of month’s worth of living expenses you want your Rainy Day Fund to cover. Supplement your monthly deposits from regular income with a portion (or all??) of any one-time income events (yearly bonus for example) until you reach your goal savings level. After withdrawals are made, Job 1 for your monthly savings surplus is replenishing Rainy Day.
Own Your Umbrella
Like all things at the intersection of life and finances, everyone’s situation is different and personal. No one needs 6-Months Expenses on day 1 they start building a fund, and most folks can skate by on substantially less than this goal (me included). Some are more risk tolerant where others are more risk averse – our individual comfort level with risk will factor into the size of the Rainy Day Fund that we need. Regardless of size, having one will help you sleep at night – guaranteed. And having a fund of the size you deem correct is key to moving on to the next goal toward financial success.