Why it's important to save
Raise your hand if you鈥檝e ever tried to build an , then gave up after an unexpected expense drained away everything you managed to save.
If that鈥檚 you, then you鈥檙e likely part of the 47% of Americans who recently told the Federal Reserve that they wouldn鈥檛 be able to pay an unexpected $400 expense without borrowing or selling something. Some said they wouldn鈥檛 be able to come up with the money at all.
That Fed statistic prompted a recent Atlantic magazine cover story, In it, author Neal Gabler confesses to being one of the many people living paycheck to paycheck despite 鈥渁 solid middle- or even, at times, upper-middle-class income,鈥� as he puts it.
The piece gathered thousands of comments 鈥� many of them, inevitably, focusing on Gabler鈥檚 numerous missteps and bad decisions.
It鈥檚 human nature聽to focus on those as a way of saying, 鈥淪ee, I鈥檓 smarter than he was. Bad things won鈥檛 happen to me.鈥澛燘ut obsessing about his blunders, such as draining a small 401(k) to pay for his daughter鈥檚 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鈥檛 really matter if you鈥檙e an innocent victim or if you invited disaster with a series of bad choices. What鈥檚 changed is how much worse the fallout can be when the economic winds are in your face.
What鈥檚 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鈥檙e not just talking about individuals coping with shrinking financial prospects. We鈥檙e talking about millions, about whole classes of people 鈥� including what鈥檚 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鈥檚 Survey of Consumer Finances released in September 2014.
When most of the country is significantly poorer after 15 years, you can鈥檛 blame Americans鈥� financial fragility on ill-considered latte habits or even overspending on daughters鈥� weddings.
So I have sympathy for Gabler鈥檚 argument that he can鈥檛 break free from the paycheck-to-paycheck cycle, that 鈥渢he primary reason many of us can鈥檛 save for a rainy day is that we live in an ongoing storm.鈥� He goes on to enumerate unexpected expenses, large and small, then quotes a New Yorker cartoon captioned, 鈥淲e thought it was a rough patch, but it turned out to be our life.鈥�
When it鈥檚 that bad, how can saving matter?
The thing is, you don鈥檛 need to save that much to make a big difference.
A recent Urban Institute study found that small amounts 鈥� 鈥� can insulate lower-income families from hardships after an income drop. Families with聽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.聽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鈥檛 less important because it鈥檚 grown harder to do. When you can鈥檛 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鈥檒l have dental bills. Pets will need to go to the vet. And so on.
You may not be able to predict exactly what you鈥檒l pay, but estimates based on past experience or even general rules of thumb 鈥� like allocating for yearly repairs and maintenance 鈥� can get you close enough. It makes a lot more sense to put this money aside first, and live on what鈥檚 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 ; they eventually add up.
Define 鈥渆mergency.鈥� If you dip into your savings every time your checking account is on fumes, or when you 鈥渄eserve鈥� a treat, the money won鈥檛 be there when you really need it.
Stick with it. Saving isn鈥檛 something you do once. You keep going, and if expenses deplete your savings, you focus on rebuilding your cushion. Even after you鈥檝e 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 , like bankruptcy 鈥� assuming they could find the money to file 鈥� to get a fresh start.
But most people can do this.
Let鈥檚 start with the bottom of the economic ladder. The notion that the poor can鈥檛 save is a myth that鈥檚 been disproved by research around the world, says Gail Hillebrand, head of consumer education and engagement for the Consumer Financial Protection Bureau.
鈥淚t has been consistently shown that [the poor] can save and they can set goals,鈥� Hillebrand recently told a panel at the Federal Reserve Bank of Chicago鈥檚 financial literacy summit. 鈥淎cross the economic spectrum, wherever you鈥檙e starting, financial capability skills can make your life better, and that includes saving.鈥�
What matters most isn鈥檛 your income or life circumstances聽鈥� it鈥檚聽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聽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.聽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鈥檚 not 鈥榦ne and done鈥�
When it comes to short-term savings, it鈥檚 important to remember this is not a 鈥渙ne and done鈥� 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 鈥渞inse and repeat鈥� part of savings that so many people miss and that causes them to give up on an emergency fund 鈥� even though the fund did exactly what it was supposed to, by providing money when they needed it.
Saving isn鈥檛 pointless, in other words. These days, it鈥檚 essential. It鈥檚 what stands between you and the financial shocks that could send your life into a tailspin.
Liz Weston is a columnist at NerdWallet, a personal finance website, and author of 鈥淵our Credit Score.鈥� Email:聽lweston@nerdwallet.com. Twitter:聽. This article first appeared at .
