Why You Need Three Months Living Expenses

If for some reason I was not able to work tomorrow for whatever reason, I would want to know I had money in place to pay my bills at least for a few months, until I could work out how to move forward or went back to work.  To me it’s a bit like seeing an iceberg approaching your boat and thinking this doesn’t look good just before it hits. It’s better to be at least keeping an eye out for icebergs as you’re sailing along.

I,  maybe you’re in a similar position, don’t want to be at a point where  the financial future of my daughter with additional needs is in jeopardy.  She faces plenty of challenges, without me adding my lack of planning to that .

I know that, in the event of redundancy or losing a job, three months living expenses won’t solve the problem, but it will offer me the chance to adjust budgets and give me time to think.  Without this sort of buffer, I would probably make silly decisions rather than ones that would help solve the problem long term.

And that’s the secret: adjusting.  The three months of full living expenses in the bank could be stretched to cover six months with a few budget adjustments. In my own case I would speak to my biggest creditor – my  mortgage company and hopefully negotiate to take a payment holiday or do something else to reduce the payments. This would give me time to then plan a way out of my situation.

The time I first realised I need this sort of buffer was after the 2007 crash .  When one bank in the UK closed its doors, it was pretty obvious  we were heading for a recession. And like that bank I’m afraid I was guilty of not having enough emergency reserve.  At that point I still had in the back of my mind, there’s always a credit card if we get into real trouble.

This financial meltdown got me into action. So to get a reasonable reserve, the first thing I did was set a realistic timescale.  I chose three years to save the three months. Three months living expenses in three years so I only had to save one month, in one year.  And then I realised that building up three months living expenses was just 8% of every item on the budget per month.

First we overpaid on our mortgage.  We did this by increasing the  payment from the bank by 8% per month.  We had the type of mortgage where overpayments could be used towards what the call in the UK a mortgage holiday. So really we were saving money in our mortgage and getting the added benefit of paying less interest. Second, we calculated what 8% of each of every other item on our budget was.  That is, we added up gas, electric, food, entertainment etc, and multiplied it by 8% . The answer was what we needed to put aside in a savings account.  In truth, after saving up for our initial Emergency Fund , we were already in the habit of saving.

Then it was just time and sticking to the budget.  Sometimes things aren’t always a straight line, and we dipped in to the extra savings to tide us over Christmas, but that was balanced by the fact we had managed to put a little more than 8% aside most months.

The lasting benefit of having saved this money was peace of mind.  To get an emergency fund and then to follow that by three months of living expenses created a real feeling of financial security.  Ok it wouldn’t fully replace a job, if something like that happened we would have to look for other ways to earn an income.  Having that reserve, though, puts me in a good position.

I believe that this three months living expenses is the minimum I need in reserve before I can Hand adding another brick to a wall made from colored blocksreally look forward to creating real financial security for my daughter.  At the end of the day my financial strategy is an us + 1 approach.  That is, Debra and I need to secure our own financial future plus the one of our daughter.  To do that we need a solid basis from which to begin.  I also remind myself that statistically money worries are one of the biggest causes of arguments between couples.

This week and in the past two weeks in My Biggest Budgeting Mistake and getting an Emergency Fund I have talked about saving money but next week I’ll be taking about debt.  While I had debt, I couldn’t really move forward as I wanted to on planning for my own and my daughters financial future.

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More From The Planning Ahead Series
Emergency Fund
Budgeting Mistakes