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Rainy Day Fund

Posted on by Econogal

Creating the Rainy Day Fund

Creating the Rainy Day fund is both harder and easier than it sounds. Yes, quite the dichotomy. Saving money is hard because we have a consumer led economy. Consumption makes up about seventy percent of the United States Gross National product (GNP). Thus spending money is pushed in our society. Unfortunately, this is antithetical to creating a rainy day fund since savings is seen as a leakage to consumption. And thus detrimental to growth. But my premise is savings is a necessary part of an efficient economic system.

The current pandemic is an excellent example. Temporary lay-offs have stretched to six months. Companies big and small are in financial distress and so are the families of their employees. Keynesian economics fought back in the U.S.A. with the PPP program and monetary payments to a good portion of the working population.

But think how a rainy day fund could have eased the burden on families, companies and government at all levels; local, state, and federal.

Steps to Creating a Rainy Day Fund

The key step to creating a rainy day fund is to live within your means. Money spent must be less than money earned. This sounds simple, but many, many people do not follow this principle. Why? Perhaps there is confusion on needs versus wants. Or maybe individuals who have satisfied the lower steps of Maslow’s Hierarchy through spending, believe the upper levels can be reached through more spending-they can’t, but that should be discussed another day.

Needs versus Wants

However, drilling down into needs versus wants is a critical first step in creating the rainy day fund. A simple exercise helps illustrate this concept. Get out a piece of paper and divide it into three columns. In the first column write down everything you need to buy in the next 48 hours. Maybe you are out of milk or your gas tank is empty, these types of entries are what you are striving for. In the second column, write down everything that must to be purchased in the next month. Again, only write down what is absolutely needed to meet the basic needs of water, food, clothing and shelter. Finally, use the third column to list everything your heart desires. These are your wants.

Now compare the columns. Do you have the funds to cover the first two lists? If not, what is your plan? These of course are necessities. They relate to the base of Maslow’s Hierarchy. Those individuals not able to meet the needs of these first two columns should evaluate why they can’t and make changes in lifestyle. Seeking help from professional financial planners may be warranted.

If you do have the needed funds, how much money is left over? And what do you do with it? My observation leads me to believe most people start buying things off that third column until there is no money left. Unfortunately, a few keep buying on credit even after all income is spent.

Delaying Gratification

The first step to creating a rainy day fund is to hold off on purchases from that third column. However, delaying gratification in our society of instant everything is now an alien concept. And there is a place for convenience. Restaurants with drive through windows have weathered the pandemic storm better than others. Plus the adage of time is money comes into play with respect to buying clothes versus making them. However, self-sufficiency comes into play with saving for a rainy day.

Expenditures from that third column in the above activity need to occur after a financial cushion has been established. First you must pay yourself by saving the extra money, not rewarding yourself with new shoes or a pumpkin latte. So how much is left over after paying for your monthly needs? According to the U.S. Bureau of Labor Statistics (BLS) in the recently released consumer expenditures for 2019, about 15% of income is available for discretionary spending.

To Econogal, this is disheartening. As you can see by clicking here for the report, the necessary expenses include Housing at 32.8%, Transportation at 17%, Food is 12.9%, Personal insurance and Pensions take out 11.4 percent. 8.2 % is spent on Healthcare and 3 % for Apparel and Services. Add everything up and the average household has spent 85.3% on needs.

The numbers get gloomier from here. (Hence the nickname The Dismal Science for economics.) Let’s say you recently graduated from high school and the only job opportunity due to the pandemic is paying minimum wage, $7.25 an hour. Looking at the numbers, income is $1160 a month or $15,080 a year. If you are frugal and don’t buy anything from column 3, savings after one year will amount to $2262 which is less than a two month cushion. Furthermore, even I am not that frugal.

Frugality

So how can one get ahead? After all, the above numbers reflect living within ones means. Two components are needed to increase the rainy day fund. Frugality and productivity. The BLS statistics are an average. Individual expenses vary. As do needs and opportunities to save. Each person can choose where to beat the average. From a personal standpoint, housing and transportation are where I beat the average. With the exception of one period of less than three years, I have never spent more than 25% of income on housing. Thus, I enjoy an 8% advantage over the average. In the above minimum wage example that would yield an additional $1200 for discretionary income.

In my opinion, the categories which yield the biggest potential for beating the average are Housing, Transportation, and Food. Aim for a cap of 25% on housing. This should include utilities. But savings can be had by eliminating items such as cable or satellite.

Transportation is another item to look at. What are the options? Can you carpool or take public transportation? In America we seldom walk to work. Even if we live close to work. The campus I taught on was less than half a mile away. Many days I chose to walk and more often than not I was asked if I needed a ride.

Carpooling, walking and combining errands into one trip have the benefit of cutting gas expense. But the fuel tank is only part of transportation cost. Wear and tear on the vehicle shows up in the price of new tires and oil changes. Another benefit to reducing transportation cost is environmental. Just something to think about if you want to reduce your global footprint. Europe and much of the world is way ahead of America in regards to transportation as a percentage of household expense.

Productivity

The second component to increasing savings and thus creating a rainy day fund is productivity. Technically, productivity is measured by dividing outputs by inputs. With respect to labor, if your cost for labor exceeds the money gained from selling the output of labor then you are in trouble. But that is at a corporate level. What about the individual?

How does one measure their own productivity? Earned wages reflect a person’s productivity. Minimal skill levels usually correlate to low pay scales. In the above example of the minimum wage annual income, a pay increase is unlikely without the development of skills via experience or education. Or both.

But an increase in wages does not automatically create a rainy day fund. In fact, economic theory argues that increased wages leads to increased consumption. An individual making $20,000 will spend 85% of their income as will a person making $100,000.

So can an Individual put money aside? We circle back to delaying gratification. Thus, creating a rainy day fund is independent of income amount. Instead, self-discipline is the key to accruing savings. Delay buying from that third column in your early years of earning a living.

Self-sufficiency

Additional ways to save money tie to self-sufficiency. This gets a bit tricky especially in a service based economy. Self-sufficiency also is counter to specialization. But I think it is time to discuss how self-sufficiency can add to the rainy day fund.

One of the economic textbooks I used began with an illustration of how the author is more productive spending his time as an economist versus mowing his yard. He posited that someone making $50 an hour should never mow their lawn because of opportunity cost. Hiring someone to mow costs less than $50. So the economist is ahead of the game by hiring the service to mow while he works.

There are problems with this theory if you are not self-employed. (And even if you are!) The college I worked for only paid me for 40 hours of work. No overtime. None. So in my case there were many hours left in the week. (Even when I did work extra hours.) I had more money for my rainy day fund when I used those hours productively around the home.

At one point in time I investigated hiring someone to come into my home and clean for three hours a week. The lowest price quoted was $50. So to this day I do my own housecleaning. That is at least $2600 a year not spent on a service. Extra savings for the rainy day fund.

There are 168 hours in a week. Even if you sleep for a third of those hours, that leaves 112 hours. Subtract 40 and you have 72 remaining. Put those hours to productive use and you will have a rainy day fund in no time at all.

Rainy Day Fund-Important Regardless of Age or Income

Life is not predictable. Hurricanes, floods, fires and tornadoes and even once in a lifetime pandemics are unexpected but naturally occurring. Natural disasters are not the only challenge in life. Accidents, illnesses and layoffs are part of life. The longer we live the greater chance of facing multiple challenges.

A rainy day fund is necessary. If you do not have a fund do not delay. Set aside money on the next payday. The more you earn, the greater amount you should have set aside. Returning to a lower standard of living is not fun-but sometimes necessary. Remember delayed gratification and productive use of time are the key components of creating a rainy day fund.

Financial Literacy Month

Posted on by Econogal

April is financial literacy month. So naturally, Econogal needs a post with tips on teaching financial literacy. Fortunately there are many ways to engage young people in learning financial responsibility. Even the youngest of children can appreciate a piggy bank.

In fact, two of my children received piggy banks from the OB-GYN who delivered them. At least one of the others was gifted a bank at a baby shower. Piggy banks are a fun way for the young child to begin saving. Some banks use piggy banks as marketing items.

Once the banks are filled, the kids can either roll the coins or use a coin sorter. The age of the child will determine the needed coordination to roll coins. A few banks will even allow kids to watch their large coin sorter. Just ask the next time you go to your bank.

Credit Cards versus Lay-away

Saving coins is just the first step. Many other lessons are needed. One of the most important is budgeting. In these days of plastic payment it can be especially difficult for kids to understand how transactions work. A swipe of the card at the check-out does not help with the concept of budgeting and payment in the same way as putting an item on lay-away. But the two are similar.

Although lay-away still exists, it is far more common to buy with a credit card. Both involve multiple payments. But with the credit transaction there is instant gratification. This is a two-edged sword. The item isn’t truly owned until paid in full. Many individuals forget this key concept. Using credit to buy expensive items or charging large amounts on services or vacations is a sure way to find yourself underwater financially.

Thus, if you have a store that still offers lay-away, consider using this avenue to teach the idea of budgeting. The child will understand the need to save to make each of the regular payments. The item will belong to them at the end of the lay-away. If this type of payment is not available, create your own system at home. Have the child put aside a certain amount each week until the amount needed for purchase is needed. Then go to the store. We need to get away from instant gratification.

Allowances or Earnings

Some families provide allowances. Others exchange payment for chores upon completion. Still others expect kids to pitch in as part of the family responsibility. Regardless of your methodology, kids can learn to participate in work at an early age. Work ethic is an integral part of financial responsibility. It is important to teach the concept of the exchange between work and pay.

Continue to emphasize savings. Either encourage or require the deposit of some of the allowance or chore earnings into a bank account. If possible, consider a small match of savings. This concept found in the working world of employee match for 401K deposits is important. Many individuals lose out by not contributing to these retirement accounts. Introduce the idea at an early age.

Track Spending

A problem faced by teenagers (and adults) is not knowing where all the money is going. A great exercise is keeping track of all expenditures in a month. All means all, down to the very last cent. For this exercise to work, several things are involved.

First identify income sources. This should include wages from part-time jobs, allowances, and gifts. College students can include scholarships and work-study.

Second, estimate how the money is spent. For example, a third is going to gas, a quarter is deposited in a savings account. The remainder might be broken into multiple uses.

Next, create a record. This can be as simple as a folder with notebook paper. Or an accounting ledger book could be used for those interested in accounting. The record needs to identify each day of the month. After creating separate daily logs, the information can further divide. Additional divisions could include categories such as food, rent, gas, and of course discretionary spending. Receipts should be kept.

Then, at the end of the month, analyze the expenditures. This is eye-opening. My students often discovered a large amount was spent on fast food even though they were paying for the college food service. Others underestimated daycare expenses because they did not include babysitting during evenings. The analysis is key in understanding spending habits. Unfortunately few save any money at all much less a quarter of the income.

Financial Literacy

These are just a few ideas for teaching financial literacy. While some states have incorporated financial literacy in the curriculum, parents need to take the lead. Start with a piggy bank and move onto a coin sorter. Kids are interested in how money works. Help them out by introducing financial responsibility at an early age.

Make sure budgeting is a concept they know and understand. Unfortunate events can wipe out a family, but far too many are in trouble from out of control spending. Instant gratification needs to be replaced by the satisfaction of payment in full. If you use credit/debit cards instead of cash, make sure the youngsters understand the payment transactions involved. An increase in the savings rate is necessary for long-term financial stability. Share this habit with your children.