Start by saving $1000
It’s good advice.
Let’s face it: when you are just starting out, it takes a long time to save money. It can feel like it is taking forever to save your first $1000.
But, that first $1000 forms the basis of your emergency fund. It is the thing that will cover life’s unexpected obstacles and keep you from back-sliding into ruinous debt. If you are just starting out, working diligently until your savings account (not the spending checking account!) has at least $1000 in it.
- Blown tire? You’re OK
- Dental emergency? You’re OK
- Flight home for a funeral (outside of COVID-19)? You’re OK
- Family member in need? You can help
- Home repair? You’re OK
Enough with the lecture; you know you need to save the money for your emergency fund. Let’s explore why it takes so long as this is where the real opportunity exists.
Saving $1000 is not the only place your money goes
Your emergency fund (or whatever other savings goal you are working towards) has a lot of competition:
- Taxes
- Retirement savings
- Required expenses (housing, food, transportation, child care, etc.)
- Desired expenses (entertainment, vacation travel, subscriptions, splurges, etc.)
Or, when considering a purchase, a lot of folks will tell you to take the purchase price and divide by your hourly wage. That will tell you how many hours you must work to afford the purchase.
Let’s say your family has single income earner and they earn the median US American household income of about $63,000/yr. At 2000 hours per year, their hourly rate is $31.50. Conventionally, you need to spend 32 hours (1000/31.5) to fully fund the first $1000 of your emergency fund. That’s less than a week of work! Unfortunately, it’s not that easy. If it were, I would say see you next week when you have saved $1000.
You don’t keep every dollar you earn
Let’s think about it a bit differently to understand why. You don’t keep every dollar you earn; you have to pay taxes, housing, transportation, food, entertainment, and everything else you typically spend.
Lets say you earn $63,000 as before, but your saving rate is in line with the US American savings rate of 6%. (Networthify has this awesome calculator showing the relationship between savings rate and career length). This means that 94% of your earnings already pay for taxes, housing, transportation, food, entertainment, etc. Without making any changes, the money to fund your savings needs to come from your unallocated budget, the 6%.
Trouble is: 6% of $63,000 is $3,780 of savings per year. Your hourly savings rate is $1.89/hr That’s what you pay yourself. At 6% of gross earnings, that’s downright miserly. At this rate, you need to work over 1/4 of the year just to save $1000. If you start on Jan 01 with $0, you will save $1000 by April 6.
Something has to change
Lots of people write about how to mind the gap, increase your income, decrease expenses. We’ll cover our own in time, but for now, it is enough to understand why saving $1000 takes so long.