3 BASKET APPROACH TO FINANCIAL SECURITY

My grandmother used to say that you should never put all your eggs in one basket. She was right. As I see it there are three baskets into which you should put your eggs. I call them the security basket, the retirement basket, and the dream basket. The security basket protects you and your family against the unexpected (such as a medical emergency, the death of a loved one, or the loss of a job), the retirement basket safeguards your future, and the dream basket enables you to fulfill those deeply held desires that make life worthwhile.

This three-basket approach may sound simple, but don’t let that fool you. If you fill the baskets properly, you can create for yourself a financial life filled with abundance and, most important, security. In today’s blog post I’m going to give you a breakdown of the 3 baskets- how much you should be putting aside, where the money should be going and how to make it automatic!

SECURITY BASKET:
The goal with your security basket here is to put away “rainy-day money” to cover expenses in case you lose your income. Exactly how much money you need to put away depends on what you spend each month.  I generally recommend to my students and clients that they put away somewhere between 3 and 24 months’ worth of expense money.

Now this 3- to 24-month range covers a lot of ground. What’s right for you depends in large part on your particular emotional makeup. Some of my students simply do not feel safe if they have anything less than two years’ worth of cash sitting in a money-market account. I happen to think that’s a bit excessive, but if that’s what it takes to make you feel comfortable, then by all means make it your goal.

Whatever amount you decide it’s important to put this money an FDIC-insured bank account (not your regular checking account but a separate one set up specially for this purpose). Until this emergency account is fully funded, you should have at least 5% of your paycheck directly deposited into it. If your employer doesn’t offer payroll deduction, arrange to have your bank automatically transfer the money from your checking account the day after your paycheck clears. To learn more check out my appearance on NBC’s Today show where I share my 6 tips for setting up an emergency account.

DREAM BASKET:
What’s a dream account? This is where you save the money that is going to pay for your home, car, wedding, trip to Hawaii, new boat, guitar, ski lessons, cooking school—whatever your dream happens to be. Most dreams require CASH, and because most people don’t have the cash, they either borrow to pay for their dream (whether by putting it on their credit cards or taking out an actual loan), or they never make the dream a reality. In some ways, your dream account is the most important account you will have because living your dreams is where the excitement of life really is. The best way to start filling this basket is to decide upon a fixed percentage of your income that you will automatically contribute every month. I usually recommend people start by investing 3%-5% of their after-tax income. As with your emergency fund, use either payroll deduction or your bank’s online bill-pay service to have a percentage of your paycheck automatically transferred into an FDIC-insured account set up just for this purpose. If your dream is at least three years away from fulfillment, start investing the money more aggressively once your dream savings total $10,000.

RETIREMENT BASKET:
In my earlier blog post I explained the critical importance of paying yourself first—having at least 10% of what you earn deducted from your paycheck and deposited directly into a 401k, IRA, or similar qualified retirement account before the government takes its bite of withholding tax. Ideally, this deduction should total 12.5% of your income (the equivalent of one hour’s worth of work each day). But whatever you can manage, you must make the process automatic. The good news is that payroll deduction is a standard feature of most 401k plans, so as long as you’re signed up, your contributions will be automatically deducted from your paycheck.

If you’re not eligible for a 401k or similar plan and as a result use an IRA for your retirement saving, you’ll have to create your own automatic “pay yourself first” program. Tell the bank or brokerage where you have your IRA that you want to set up a systematic investment plan. This is a plan under which money is automatically transferred on a regular basis into your IRA from some other source (such as a payroll deduction). Most banks and brokerage firms will handle all the arrangements for you, contacting your employer’s payroll department on your behalf and dealing with all the paperwork. (If your employer doesn’t offer payroll deduction, you can have your retirement-plan contribution automatically moved from your checking account to your IRA—ideally, the day after your paycheck clears. Most banks have free online bill-paying services that allow you to schedule regular automatic payments of specified amounts to anyone you want).

I hope this blog post helped you gain a better understanding of the 3 basket approach to financial security and has motivated you to start funding all 3 – AUTOMATICALLY! Please leave a comment below or on my facebook page. I love hearing from all of you!

Live Rich!
David Bach

The Four Basic Rules of Emergency Money

So how do you go about protecting yourself with a cushion of money? There are four basic rules that you need to know.  

1. Set yourself a goal. I’ve always said that every family should have a cash cushion of at least three months’ worth of expenses. In other words, estimate how much you spend each month on essentials (mortgage or rent, utilities, food, health insurance, etc.), multiply it by three, and that’s your minimum goal for emergency savings. If you typically spend $3,000 a month, you want to have at least $9,000 put away in a reserve account not to be touched unless there’s an emergency. Should you try to save more? Absolutely. How much more depends on what you feel you’ll need to be able “sleep well at night.”

2. Make it automatic.  It is so important that you make your emergency fund automatic. That means every single time your paycheck is deposited, your checking account is set up to automatically sweep money into a separate savings account you’ve set up for your rainy-day fund.  I suggest you start by moving 5% of each paycheck to your emergency account until you reach the goal you set for yourself above.

3. Put it in the right place. Once you’ve made the commitment to funding a rainy-day account, the next decision you have to make is where to park it. I used to emphasize the importance of finding a place that would give you a reasonable return on your money. But these days, with interest rates at rock-bottom levels and the stability of many financial institutions still in question, I worry more about security. Of course, interest rates won’t stay in the basement forever. But until they recover, which may not be for a long time, I’d focus less on the kind of return you’re getting and more on making sure your emergency money is safe and accessible.

4. Leave it alone. The reason most people don’t have any emergency money in the bank is that they have what they think is an emergency every month. What’s a real emergency? It’s not just having to buy a new dress for that special party. Or deciding you’ve got to get a new dishwasher because the old one is making noise. A real emergency is something that threatens your survival, not just your desire to be comfortable. So unless your family is about to go hungry or be thrown out into the street, you shouldn’t be dipping into your emergency fund.