Raise your hand if you’ve ever tried to build an emergency fund, then gave up after an unexpected expense drained away everything you managed to save.
If that’s you, then you’re likely part of the 47% of Americans who recently told the Federal Reserve that they wouldn’t be able to pay an unexpected $400 expense without borrowing or selling something. Some said they wouldn’t be able to come up with the money at all.
That Fed statistic prompted a recent Atlantic magazine cover story, “The Secret Shame of Middle-Class Americans.” In it, author Neal Gabler confesses to being one of the many people living paycheck to paycheck despite “a solid middle- or even, at times, upper-middle-class income,” as he puts it.
The piece gathered thousands of comments — many of them, inevitably, focusing on Gabler’s numerous missteps and bad decisions.
It’s human nature to focus on those as a way of saying, “See, I’m smarter than he was. Bad things won’t happen to me.” But obsessing about his blunders, such as draining a small 401(k) to pay for his daughter’s wedding and keeping his wife in the dark about their money situation, risks missing the bigger picture being painted:
When incomes are growing, financial missteps can set you back. When incomes and wealth are shrinking, mistakes can derail your life.
It doesn’t really matter if you’re an innocent victim or if you invited disaster with a series of bad choices. What’s changed is how much worse the fallout can be when the economic winds are in your face.
What’s different now?
In the past, some people faced downward mobility even in good times. Anyone who was disabled or lost a job in midlife could see her income plunge, never to recover.
But these days we’re not just talking about individuals coping with shrinking financial prospects. We’re talking about millions, about whole classes of people — including what’s left of the middle class.
In the U.S., median incomes peaked in 1999 and have yet to recover, according to the Census Bureau. Our overall wealth, as measured by median net worth, has dropped 21% since 1998, according to inflation-adjusted figures from the Fed’s Survey of Consumer Finances released in September 2014.
When most of the country is significantly poorer after 15 years, you can’t blame Americans’ financial fragility on ill-considered latte habits or even overspending on daughters’ weddings.
So I have sympathy for Gabler’s argument that he can’t break free from the paycheck-to-paycheck cycle, that “the primary reason many of us can’t save for a rainy day is that we live in an ongoing storm.” He goes on to enumerate unexpected expenses, large and small, then quotes a New Yorker cartoon captioned, “We thought it was a rough patch, but it turned out to be our life.”
When it’s that bad, how can saving matter?
The thing is, you don’t need to save that much to make a big difference.
A recent Urban Institute study found that small amounts — savings in the $250 to $749 range — can insulate lower-income families from hardships after an income drop. Families with this amount of savings were 28% less likely to miss a housing payment, 24% less likely to miss a utility payment, and a whopping 78% less likely to be evicted than families with less than $250 saved. Not surprisingly, the higher your income, the more savings you need to insulate yourself from missing payments or getting evicted. The Urban Institute researchers estimated it takes at least $2,000 to insulate a middle-income family from these hardships and at least $5,000 for a higher-income family.
Those are not small amounts, especially for people starting from scratch. But saving isn’t less important because it’s grown harder to do. When you can’t count on raises or even a steady paycheck to bail you out, you need savings all the more.
How can you (realistically) save?
How in the world do you do it? You:
Predict the predictable. Many of the expenses Gabler (and others) call unexpected are actually pretty predictable. Homes and cars will need repairs. If you have teeth, you’ll have dental bills. Pets will need to go to the vet. And so on.
You may not be able to predict exactly what you’ll pay, but estimates based on past experience or even general rules of thumb — like allocating 1% to 2% of a home’s purchase price for yearly repairs and maintenance — can get you close enough. It makes a lot more sense to put this money aside first, and live on what’s left, than to live on 100% of your income and scramble every time the inevitable happens.
Start small. A $500 savings goal is a good first step. If you can sell something or use a windfall to get you started, great. Otherwise, just make small contributions regularly; they eventually add up.
Define “emergency.” If you dip into your savings every time your checking account is on fumes, or when you “deserve” a treat, the money won’t be there when you really need it.
Stick with it. Saving isn’t something you do once. You keep going, and if expenses deplete your savings, you focus on rebuilding your cushion. Even after you’ve broken free from the paycheck-to-paycheck life, continuing to save no matter what will build your financial resiliency.
Almost everyone can save something
There are always going to be people in such hopeless financial situations that they cannot save. Many would be better off filing for some kind of debt relief, like bankruptcy — assuming they could find the money to file — to get a fresh start.
But most people can do this.
Let’s start with the bottom of the economic ladder. The notion that the poor can’t save is a myth that’s been disproved by research around the world, says Gail Hillebrand, head of consumer education and engagement for the Consumer Financial Protection Bureau.
“It has been consistently shown that [the poor] can save and they can set goals,” Hillebrand recently told a panel at the Federal Reserve Bank of Chicago’s financial literacy summit. “Across the economic spectrum, wherever you’re starting, financial capability skills can make your life better, and that includes saving.”
What matters most isn’t your income or life circumstances — it’s that you make a decision to save and follow through.
The act of saving has far more to do with how much money you accumulate in your lifetime than your earnings, the random events that happen to you, or even the investments you choose, according to research by economists Steven Venti and David Wise for the National Bureau of Economic Research.
They found that some people with low incomes accumulated six-figure nest eggs while some with high incomes had nothing. There were wide variations in how much people of similar incomes managed to accumulate, but overall most of the differences in wealth had to do with whether people saved and how much.
It’s not ‘one and done’
When it comes to short-term savings, it’s important to remember this is not a “one and done” decision. You will constantly have to replenish those funds.
When the car repair or the vet bill wipes out your emergency fund, make rebuilding that fund a priority. This is the “rinse and repeat” part of savings that so many people miss and that causes them to give up on an emergency fund — even though the fund did exactly what it was supposed to, by providing money when they needed it.
Saving isn’t pointless, in other words. These days, it’s essential. It’s what stands between you and the financial shocks that could send your life into a tailspin.