A financial safety net, or emergency fund, are emergency savings that you keep handy in case something prevents you from using or accessing your traditional cash flow. Financial safety nets are used to cover living expenses, unexpected costs, medical bills, and other emergencies.
There are benefits of having an emergency fund, but assurance is the main reason to save for one. If you have money tucked away, you won’t have to struggle financially or stress over last-minute expenses. However, the amount you need is dependent on several factors.
Financial Safety Net vs. Savings
In the end, a financial safety net and savings are the same thing if you’re using both for an emergency purpose. However, most of us use our savings for large purchases, like a vacation, operation, or home renos, while a financial safety net is explicitly needed to keep you afloat.
Net Pay vs. Gross Pay
When creating your safety net, you may be wondering where you should use your net pay or gross pay to determine how much you need for savings. We recommend using your net pay as that amount is what you actually receive. Gross pay is your total pay before deductions.
After getting your paycheck, your pay stub should show you a breakdown of where your gross pay is being placed. Since the IRS and your employer use a percentage and not a set amount for most of your taxes and vacation pay, you can’t always account for your actual net pay.
It’s better to bank on a sure thing than a constantly changing variable, so use a percentage amount of your net pay to determine how much you should save for a rainy day.
How to Calculate Your Financial Safety Net
Banks and financial advisors recommend keeping at least 3-6 months of your essential living expenses in a fund to cover a reduction or loss of income. While it’s up to you to decide what you consider as “essential,” you’ll likely consider the following as necessary expenses.
- Rent or Mortgage Payments
- Debt Payments
- Alimony or Child Support
Once you determine how much you spend on your necessities, set that against your annual net income (subtract your tax rate) and your current safety net or savings funds.
Let’s say you pay 1K for rent or mortgage payments and 300 for every other necessity in the bulleted list in this section. If you make 76,000K (subtract 24% for taxes) a year and can save $150 a month of your $2,933 available monthly cash, you’ll reach your goal in 35 months.
If you can save $300 a month, you’ll reach your goal in 18 months. We recommend you use this financial safety net calculator to figure out how much you need for your own circumstances.
How to Create a Financial Safety Net
Once you’ve determined your savings goal, you still have to create a budget, prioritize, and potentially automate your monthly savings. Here’s how you can do this:
Create a Budget
If you don’t already have an itemized list or knowledge of what you make, take a look at your checking account and write down how much you spend. See where you can save money.
Start allocating money for needs, wants and savings. Keep in mind that if you need a coffee, which is typically a want, to start your day off right, you can put it in the needs column.
Automate Your Savings
It’s much easier to set it and forget it. Ask your bank to take out some funds each month from your checking account into a savings account to ensure you’re earning interest while saving.
Published on Holr Magazine