[Transcribed and adapted from the YouTube video “Money & Coronavirus: How Much to Save“.]
- COVID-19 is an emergency situation.
- Your emergency fund should be at least a year’s worth of expenses.
- How to calculate how much you’ll need to save.
- Steps to take in order to save up for an emergency fund.
- The psychology of saving for an emergency.
I know what you’re thinking: “Ramit, I’ve heard a lot of other people tell me how to save money. I know what you’re going to tell me.”
“You’re going to tell me, ‘First of all, cut back on lattes. Second of all, go open up my oven, put on some gloves, and disable that oven light because, over the next five years, you could save 13 cents. That’s 13 cents you can put right in your pocket. You otherwise wouldn’t have had it. Save the money, Ramit!’”
That’s not what we’re talking about. We’re going to talk about how to save money in a way that actually makes sense and makes a difference in difficult times, like a pandemic. Specifically, we’ll discuss:
- How much do you need to save?
- How do you save it?
- What’s the effective psychology behind saving for an emergency fund?
How to Save Money During a Pandemic or Recession
Saving is an important part of your personal finance infrastructure. A conscious spending plan means you know how much you’re saving, how much you’re investing, and how much you’re spending. Especially during times like COVID-19, a lot of us are wondering, “Am I okay with the amount I have saved?” Or, “I don’t feel safe, so I need to figure out a way to save more money right now.” I want to talk about all of those things.
I’ll just answer your question, straight up: “How much do you need to save?”
You need to have a one-year emergency fund. That is what I am recommending as your target. Previously, I had different recommendations regarding how much everyone should save — that was just my personal rule found in “Ramit’s 10 Money Rules.” However, the pandemic has caused us to think differently to be even more prepared.
Generally, what used to be recommended was three to six months. If you really want to be conservative and make sure you’re ready for anything, which is what I recommend, save enough money to cover a year’s worth of expenses. Now, let’s dig into why you need to save that much and how to get started.
Why you should save for an emergency fund
Let’s just assume the worst case scenario: you are laid off. Nothing personal! Remember, I’ve been laid off myself, it’s not the end of the world.
What do you do? What most people do is they wait until that minute and then they panic. They don’t know how unemployment works. They don’t know how much they had in savings, but they know that they should have done it a long time ago.
I want you to remember one critical factor in times where there is mass unemployment: if you are laid off, it’s not just you looking for a job. There are millions of other people who are in the same boat. That’s why, when things go wrong, pre-planning becomes even more powerful.
How to calculate your emergency fund
“One year of an emergency fund.” What does that mean? How do you actually calculate it?
What I found is that much of the expert advice out there gives you these generic phrases, but I want to connect it with you so you see exactly how much that means for you.
Here’s an example of how you can calculate how much you need to save for an emergency. For easy math, let’s assume that I spend $1,300 a month on everything: rent, car, and discretionary costs.
In difficult times like this, I’m going to cut some of my discretionary expenses. So, I cut $300 bucks off the top and now I have $1,000. Now, I know that I need a thousand dollars a month minimum to live, to keep the lights on, to be eating, etc. What does that mean? How much do I need to save for 12 months?
$1000 x 12 months = $12,000
In that very simple example, do you see what we did? First, we came up with our basic number — how much we spend per month. Then we chopped off some percentage of that. Target 10-20%, if you can. In our example, we did around 30%. Now that we’ve got that number, multiply it by 12. That is the one-year emergency fund amount that we need to be targeting.
Your calculation probably won’t be as clear-cut with nice, round numbers as our example. Simply apply that formula to your money situation and you should arrive at a number that works for you.
The psychology of saving for an emergency fund
Nobody’s expecting you to save this much by tomorrow. Oftentimes, it takes years to save up a full-scale emergency fund. If you can’t save for a year’s worth of expenses, you can save for seven months — that’s better than nothing. We’re going to target the 85% solution from my book and we’re going to get on with our lives. That is part of the psychology of accepting that you need to build an emergency fund: just take that first step.
We talked about cutting those expenses that you don’t need or that you may have been thinking about spending later in the year. For example, in light of the pandemic, I have written off the rest of the year in terms of going anywhere for vacation, weddings, or any other trips. I am anticipating that nothing will basically be open until the end of the year.
Just by paying attention to the areas that you can cut, you’re going to start to see changes. It’s like anything. If you start tracking your money, if you start tracking your eating, if you start tracking your steps, you’re going to see changes just by virtue of looking at it.
Another step you could take to get in the saving mindset is to call up your credit card company, your student loan company, even your landlord, and discuss your situation in light of the pandemic. Some companies are waiving fees, some are extending payment plans over long periods of time, they’re doing grace periods — there are lots of options. Please, take advantage of them — the options may help you save for your emergency fund.
There’s a psychological principle that finds that, just by the action of observing something, you are going to change it. If you sit down tonight and you calculate your savings, your one-year emergency amount, and you start thinking, “What can I cut?” You’re going to change it. You’re going to start building up that savings amount. And that’s your first step.
You have an emergency fund–now what?
Remember, saving money for an emergency fund is a long game — and it should be! Whether you’re saving money or running 10 miles, the first step to accomplishing a daunting task is to take that first step.
For ‘Money & Coronavirus: How Much Money to Save: Part 2,’ I’ll dive into the psychology of spending your emergency fund because that’s the exact scenario we all find ourselves in: an emergency.