Back To Basics

As a result of the financial turmoil caused by COVID-19, there is a lot of confusion about what is the best thing to do with your money? Let’s face it. Watching a paycheck disappear or get reduced is scary. And seeing investments bounce up and down daily can be unsettling. During uncertain times like these, it’s important to keep to the basics.

Just as you use a compass to navigate through a storm, use the following basic principles to point you in the right direction.

  • Focus on your rainy day fund. Although you might need to lean into your emergency fund right now, that doesn’t mean squandering it away. Try to preserve cash as best you can, and use a budget to identify where you can reduce expenses. You may already notice your discretionary spending has gone down with shopping malls closed and social outings cancelled, but challenge yourself to find extra ways to cut costs. If you are still receiving a paycheck, devote more cash to your reserves. Getting a tax refund? Put it in your cash reserve. Expecting a stimulus check? Put it in your cash reserve. When you can keep a steady 3- to 6-month emergency fund (amount depending on your level of comfort), then you can shift focus towards other financial goals.
  • Don’t sell your investments in a panic. Despite the stock market taking a bumpy ride, now is not the time to sell all your investments. Doing so could lead to significant losses that you may not recover once the market rebounds. A 401(k) loan or IRA loan may sound tempting, but taking money out of your retirement accounts could mean selling investments at a loss. Keep that in mind when weighing this option.
  • Avoid debt if you have cash. More options have become available to delay bills, like mortgage and rent payments. Be careful to examine what this means for your financial future. Simply put, these are loans, which means they must be paid back someday. Are you certain you can pay back the balance by the imposed deadline? What if, in the post-coronavirus world, wages are lower, and income doesn’t cover regular monthly bills along with what’s owed? For these reasons, it’s best to consider borrowing as a last resort, when all other cash is depleted.
  • If you have money to invest, dollar-cost average. For those who have a comfortable rainy day fund set aside and have spare cash outside of those reserves, you may be wondering what to do with your spare cash? Assuming that you’re not tapping into that emergency fund, there is no need to hoard more cash than you already have. Now that stocks have dipped to lower prices, it’s a great time to buy shares at a discount. But instead of timing the market, divide that investment over a period of time, otherwise known as dollar-cost averaging. As long as you keep a long-term outlook, chances are pretty good that you’ll come out ahead.

Navigating through a financial rough patch may seem complex, but doesn’t have to be with these basic principles in mind. As we go back to normal, these principles shouldn’t go away. Saving for a rainy day fund is always a good idea, as is keeping a long-term outlook on investments and avoiding the cycle of debt. Stick to the basics, and your money will stick with you!

Homework: To emphasize the importance of a rainy day fund and maintaining a comfortable amount, try this game with a deck of playing cards. How does your number do?

How To Play: Once the cards are shuffled, remove half the deck, and place the other half face down. You will draw from this half. Start with a number between 0 and 60; a multiple of 10 works best. As you draw a red card, subtract the number on that card from your original number. As you draw a black card, you have 2 choices: add that number or toss it. For example, drawing a red card with 6 means subtracting 6, and drawing a black card with 5 means adding 5, or 0, depending on how you decide. Royal cards and aces equal 10. If your deck includes jokers, add 10 when you draw a joker, regardless of red or black card. If your number ever dips below zero, game over. If you successfully finish through the half-deck, what number is left?

In this game, each card symbolizes money. The original number and ongoing tally is your rainy day fund. Red cards symbolize unforeseen expenses. Black cards represent income, which you can either save (add) or spend (toss). Joker cards can represent a rare windfall, such as stimulus money. Finding the right number for your “rainy day fund” and maintaining that number is key to winning the game!

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Do You Need A Rainy Day Fund?

Rainy day fund. Emergency fund. Cash reserve. Call it what you prefer, but the important thing is to have one. What is a rainy day fund? It’s money set aside to weather unexpected “storms” in your life. For instance, did your car break down, and you need money for a repair? Lost your job and need money to survive until you find another job? Have a big medical expense that came out of the blue? When you suddenly need money, you’ll be thankful that you have a rainy day fund.

To build your own rainy day fund, you need to save towards it. Make it one of your savings goals, just like any other big purchase you wish to make. As you accumulate money in your rainy day fund, you may decide to cap it after a certain amount. If you earn steady income, you may find that an amount equivalent to 3 months’ expenses is a sufficient target goal for your rainy day fund. If your income fluctuates from month to month, you may feel more comfortable with covering up to 6 months of expenses through your rainy day fund. Some people choose to continue saving towards their rainy day fund even after they reach a comfortable amount. That way, if they ever need to break into the rainy day fund, they already built in a way to replenish what was spent.

Young savers probably don’t have a reason to save for a rainy day fund. After all, Mom or Dad is the rainy day fund. Kids can break from this mentality by having something to be responsible for. What is a possible sudden expense that can hit? Maybe it’s a vet bill for your pet. Or perhaps a replacement for a broken cell phone. It might even be new cleats for soccer. If kids are given the responsibility, they will more likely build a habit of saving for that rainy day fund.

Why make a rainy day fund a savings priority? Let’s play out the scenario without a rainy day fund. You could tap into savings for other goals to pay for this expense. But that means giving up or delaying those other goals. Some goals, like college or retirement, don’t have much room to postpone. If no savings exists, you would need to borrow money. Borrowing money requires that you pay back the loan, with additional interest, and that payback eats away at the money you earn. Not to mention if another unexpected expense occurs, even more money goes into paying debt. To prevent debt from taking control, put that rainy day fund first!

Regardless of what other financial goals you have, a rainy day fund should be at the top of your list. If it suddenly rained, wouldn’t you rather have an umbrella? That is exactly how a rainy day fund works!

Homework: What is the right amount for your rainy day fund? If you do not have one already, how much can you devote from monthly savings to build your rainy day fund?

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