By Carolyn Bahm
One thing's certain about saving for a rainy day: Financial thunderclouds always arrive sooner than expected.
Everyone needs to save money, whether it's for a down payment on a car, a first house or simply an emergency fund. (What happens if a wage earner in your family is disabled? How will you make house and car payments and meet other immediate living expenses until your insurance coverage kicks in?)
Up until about a year ago, the old rule of thumb used to be saving three months' income just as an emergency cash reserve. Today it's stretched to six month's income, according to Cathy A. Davis, manager of the Tupelo office of Consumer Credit Counseling Service.
That's because a lost job today is harder to replace, particularly at the same salary level. You'll need a plump financial cushion.
At a bare minimum, cash reserves should be at least two weeks' to a month's salary, according to Sam P. McClatchy Jr., president of Trustmark National Bank in Tupelo.
There's a subtler financial pitfall at stake in today's economy, too. People make the mistake of relying on overtime hourly wages, McClatchy said. Then they are skewered by debt when their plant eliminates all overtime work or worse cuts back from the standard 40-hour workweek.
Why should you start saving for that emergency fund today? The time factor, Davis said. If you are able to save 10 percent of your net income each month, it will take five years to salt away that ideal six-months' cash reserve. That's not including any other savings you'll need to amass meanwhile.
Major financial milestones
Parents face a staggering extra burden in paying for their children's education. Assuming a 6 percent annual rise in college costs, a child age 10 today can expect to pay an estimated $44,500 at the average public university, $98,800 at a private university or $164,700 at the top-priced private universities. That includes only tuition, fees, room and board. Don't forget the child is going to need more money for transportation, clothing, any extra medical insurance and spending money. (Figures were provided by "College planning ..., " a free booklet available at American Express Financial Advisors Inc., Tupelo office.)
Retirement is the other major savings goal for most people. Depending on your income level, you can maintain a constant level of living if your retirement strategy yields 50 to 80 percent of your pre-retirement income. Relying only on Social Security payments for retirement income is a sure way to take the glow off your golden years; if the program survives its own financial problems unchanged, retirees can expect benefits that replace only about 25 to 50 percent of their pre-retirement income, depending on their income levels. (Source: "Financial Planning for Retirement," a free booklet provided by the Mississippi Cooperative Extension Service.)
People also are living longer; a 35-year-old woman today can expect to live about another 45 years. Those who don't save money can get caught short. Davis sees many elderly clients who tried living on their credit cards for the first five years of retirement.
One 80-year-old man was trying to live on a $400 monthly Social Security check and still support $30,000 in credit card debts, Davis said. "He was doing without food. Sure, he was living in subsidized housing and he had help with the utilities, but there's only so far you can stretch $400 per month."
The 'can't do without' mind-set
Excessive debt is a roadblock to savings for people of all ages. A young couple came to Davis for counseling, both in their early 20s and fresh from college. He made a comfortable $2,400 monthly net income. They had just had a baby, and she wanted to remain a homemaker. They were trying to balance their goals with their income, their normal living expenses, repayment of $40,000 in student loans and mountains of bills. The two had leaned heavily on credit cards during their college days, saddling them with an additional $30,000 in credit card debts.
Robert W. Chesnut, a certified financial planner for the Tupelo office of American Express Financial Advisors Inc., speculated on why people reach for the sun, moon and stars all at once. "Today it's 'instant satisfaction.' They don't want to wait and plan. And I think that translates into the way they manage their money."
Even credit addicts can reform. Most of Davis' recovering clients take one to three years to climb out of debt (and severe cases can take longer). When they do pay off old bills, she advises putting some of that money into savings instead of a relaxed budget.
"I tell them, 'You've been paying $600 a month toward these bills, and you've still managed your household. ... It makes sense now to put part of that surplus into regular savings."
Taking that first step
How to get from precarious finances to security: Save early and save often. Excessive spending habits are a common obstacle.
"We are geared to live to every last penny," Davis said. "We base our self-esteem on what we have."
Too many people live on the precipice of financial disaster, skidding closer to the edge each month. People in the United States tend to save about 5 percent of their disposable income, according to Merv D'Mello, a personal financial advisor also with American Express in Tupelo. That's the lowest of any industrialized nation in the world.
Recovery to a more secure financial zone means saving money. That means discipline.
Davis said a single client "couldn't" save money until he stopped having every meal at a restaurant: He didn't like cooking, but he liked it better than blowing $365 per month on food.
Even minor cutbacks help, she explained. Someone who buys a soft drink every afternoon can save that 50 cents five times per week. Saved at a 5 percent interest rate, that pocket change will emerge as $1,559 in savings after 10 years or $4,127 after 20 years.
Smokers who save just $1 daily by changing their smoking habits can invest the money at a nominal 5 percent interest rate and save $4,677 over a decade, or $12,381 over 20 years. (In both the soft drink and smoking examples, the savings are calculated with monthly compounding and do not include applicable income taxes.)
"It takes willpower and discipline," Davis said. "A budget is worse than a diet. We try to call it a spending plan. That's a little easier to swallow."
A personal financial plan is a broader way of looking at income, outgo and financial goals. These plans should answer four key questions, according to the American Express Financial Advisors Inc. booklet, "Personal Money Management":
- Where am I now financially?
- How much money will I need to meet my objectives?
- How much time do I have?
- What can I do right now to achieve my objectives?
An overall plan is crucial, D'Mello said. Life without a money management plan can be turbulent. "It's like you going to Florida without a map. Sure, you may get there after all, but have you gone the most efficient way? And have you brought enough money for gas?"
Where to put your nest egg
Once you've decided how much money you can save regularly, then you have to weigh your choices of where to put your savings. How do you choose from stocks, bonds, mutual funds, money funds, certificates of deposit (CDs) and other investments? How do you select from savings and retirement plans, annuities, trusts and estate planning tools?
There's no one sure-fire answer for every situation. Advice differs on where to put savings, depending on your assets, goals and timetable, Chesnut said.
Your overall financial plan and savings should cover four basic areas, according to various experts:
- Cash reserves to meet immediate needs.
- Adequate protection to provide money in the event of an emergency. This protects the things you can't afford to lose, and it includes adequate insurance of all applicable types.
- Fixed assets (money invested at fixed rates of return, usually for a certain length of time and for special purposes). These stable, more conservative investments provide income at predictable rates of growth.
- Equity assets, money invested to help you achieve a more aggressive, attractive rate of financial growth.
The first baby step is usually the budget. Don't forget to save money for irregular expenses (annual car tag payments, quarterly insurance bills, medical deductibles and federal and state taxes, for example).
"Anything with a biannual or semi-annual payment needs to be pro-rated and that amount set aside," Davis said. "And that's what usually blows people out of the water."
Be sure the budget also includes adequate insurance. Long-term health care, a devastating home fire and other disasters can ruin even the most careful savings plan if you don't have enough insurance, D'Mello said.
After building a cash reserve comes a look at long-term goals and how to reach them.
An important element of saving money is deciding how much risk you can tolerate, said Dot Kelly, president of Century Financial Services of Mississippi Inc. in Tupelo. Will you panic every time the market drops? If it will keep you awake at nights, opt for more secure investments. Can you comfortably put the money aside for a long time? If so, you can afford to tolerate a higher risk.
In most cases, people need to remain in the stock market for at least one and one-half to five years to get the most benefits, she said.
Kelly also cautioned against putting all your money in one stock. She recommends a mutual fund as a good idea for small investors (people with about $5,000 or less). Otherwise, it's difficult for these investors to diversify. Another mutual fund benefit is the ability to add money monthly.
For education savings, she said many people favor zero-coupon treasury bonds. People can buy them at a discount (perhaps as low as 30 percent of the face value, given a long-term investment), then redeem them when they mature at their face value. Others invest more aggressively when the child is young, then turn their growth-oriented stock and mutual funds into conservative investments (such as government bonds or CDs) as they approach the time the money is needed.
A simple starter savings plan would be depositing the same amount of money into a savings account every pay period, McClatchy said. When you get enough, buy a certificate of deposit. Choices between long-term or short-term CDs will vary with interest rates.
Usually, there's a significant difference between short- and long-term CDs, but on Thursday McClatchy quoted a negligible spread a fourth of 1 percent (.25 percent) difference. He advised checking with your bank for current details when you buy a CD.
"If rates are not that much different, don't put it in long-term," he said. He also advised on good planning to avoid penalties for early withdrawal from a CD.
Another excellent way of tucking away funds is through payroll deduction; most folks are less likely to squander the budgeted savings amount if the money never passes through their hands.
McClatchy said, "If you can do it through your company, that's the way to go."
D'Mello and Chesnut agreed, saying it's especially good when the company matches your invested funds. They both recommend taking advantage of corporate 401K plans.
They also advise checking into individual retirement accounts (IRAs) for long-term goals and tax advantages. If you're going to save money, try to find a vehicle that is tax-exempt or at least tax-deferred, D'Mello said. "Don't pay taxes on something you don't need right now."
D'Mello also debunked four common money myths and mistakes:
- You're paying it safe, banking solely on FDIC savings because it's insured. D'Mello said the trade-off is a low interest rate. "The only thing FDIC has an advantage over is putting your money under the mattress."
- You "save" money by getting a big tax refund. Wrong, D'Mello said. "You're giving the government your money for no interest."
- You're planning on an inheritance from a relative as your retirement nest egg. What if the relative runs through the money with high medical bills, or what if he lives to be 95 and needs the money himself?
- You're relying on the business you own to fund your retirement. What if sales slip or you go out of business? Even if the store remains successful, you can get nabbed: If you need money and sell the business, you'll generally fall prey to a gigantic, crippling capital gains tax.
However you choose to invest your money, D'Mello had two crucial pieces of advice: Diversify your savings and allow time, time, time for your money to grow.
"You can't start too early," he said.