Saving Can Be a Financial Shock Absorber, So Set a Plan

Budgeting, Personal Finance
Saving Can Soften Financial Shock, but You Also Need Strategy

A busted water heater. A burst appendix. A blown engine. A divorce. A layoff.

More than half of U.S. households experienced some kind of financial shock — an unexpected expense or loss of income — in 2015, according to a new report by The Pew Charitable Trusts.

The effect of these shocks can ripple through a family’s finances for months or even years, particularly among lower-income families.

Of those who experienced a shock in 2015, 53% struggled to make ends meet in the aftermath, the study shows. That figure jumps to 74% for families with an annual household income of less than $25,000, according to the report, which surveyed thousands of respondents in both 2014 and 2015 as part of its Survey of American Family Finances.

Savings doesn’t provide immunity against financial instability, but the study indicates it does significantly improve a family’s ability to weather the storm. Even $2,000 can make a difference in hard times.

“We see, for all different sorts of households, the effect of having that bit of savings to turn to when times are hard,” says Clinton Key, research officer for financial security and mobility at The Pew Charitable Trusts.

In fact, among families with at least $2,000 in liquid savings — such as money in checking, savings or cash — 51% who experienced a shock said they struggled as a result of it, compared with 70% of those with less than $2,000 in savings. Almost 80% of those with no savings said they struggled to recover after taking an unexpected financial hit. (Savings figures were based on the 2014 survey, while the financial events were reported in the 2015 survey.)

Certainly, savings can help mitigate financial shock. But where should you start?

Get an emergency fund going

The study also found that 70% of families who experienced a shock in 2014 had another in 2015 — illustrating the importance of building and maintaining an emergency fund. Ideally, that fund would be enough to cover three to six months’ worth of living expenses.

Many families may find that figure daunting, but the key is to just get a fund going. Start small and set an achievable goal, such as “save $1,000.” Make your saving automatic, or find other ways to make it happen.

Then, track your spending. Use a budget to see the money you have coming in and going out each month, and find extra savings where possible.

Know what constitutes an emergency

It’s also important to know when to tap into your savings.

“We’ve seen households in financial distress, but [they] don’t know if it’s bad enough to tap into their savings — if today is the day it’s really raining, so to speak,” Key says.

If the expense or loss of income will prevent you from paying your mortgage or bills on time, it’s safe to dip into your savings. But the other key is to work to build your savings back up as soon as you can.

“The whole point of an emergency fund is to protect you from something worse, such as going into debt or not being able to pay a bill,” says NerdWallet columnist Liz Weston. “So while you don’t want to waste your savings on frivolous purchases, you also shouldn’t hesitate to tap your emergency fund when you need it — and then focus on saving up to replace those funds. Saving for emergencies is something you do continually.”

Prepare for emergency as much as you can

You can’t foresee many financial shocks, but take stock of where you’re most vulnerable and be as ready as possible. Major home and car repairs accounted for nearly 50% of financial shocks families experienced in 2015. Trips to the hospital made up another 20%.

A health savings account can help ease the sting of the latter, while a separate savings account for your creaky furnace or squeaky transmission allows you to pay for either without dipping into your emergency fund.

Kelsey Sheehy is a staff writer at NerdWallet, a personal finance website. Email: ksheehy@nerdwallet.com. Twitter: @KelseyLSheehy.