Having savings that allow you to make ends meet even for a few months without a source of income is something everyone should strive for. This is what a financial cushion is. It brings us peace of mind and a sense of security. It protects us from unplanned events and expenses, which is especially important in turbulent times. How much is enough to be effective, and how to start building it? Here's everything you need to know about a financial cushion.
To explain this term closely and show why it is important, let's see how the "saving sphere" looks like in one of the European countries, namely Poland. Almost ¼ of Poles do not have any savings at all - reads the report "Savings Barometer" commissioned by National Debt Register (Krajowy Rejestr Długów). 17% of the surveyed indicated that they have no more than 5,000 PLN set aside for a rainy day. In turn, 11.5% of respondents have less than a thousand PLN.
In the case of job loss and other sources of income, 26% of Poles declare that their savings would allow them to survive for at most 3 months. Without additional support, only 17% of respondents could survive up to six months. However, a vast majority declares that with the money saved, they would live only a week (7.5% of respondents) or at most 2 weeks (9% of respondents).
Things will work out in the end
What is the reason for such figures and why Poles do not save at all? Some of them indicate that their income is simply not enough, which makes it impossible to have even a single zloty to cover unplanned expenses. Others are just not afraid of what tomorrow may bring and are not worried about their financial situation. They assume that "it will work out somehow".
What is lacking in society is awareness and rational money management. Many people live from payday to payday, not worrying about the future. Instead of saving for a rainy day, the average person prefers to buy a new TV set or go on a foreign trip. They live here and now without bothering about savings. There is no habit of saving money and gathering additional funds, e.g. for retirement.
Poles tend to prioritize obligatory expenses (bills, house or apartment payments, loan repayments, food), followed by pleasures, and only then savings. They only put money aside if they have some money left over at the end of the month or if they have an additional, unexpected income.
American billionaire Warren Buffet presents a very interesting approach, completely contrary to the way many think. He claims that savings should come first, followed by compulsory expenses, and only at the very end - pleasures, which we can give up if necessary.
If we truly consider saving as a high-priority and mandatory goal, it will come easier and building a financial cushion will be somewhat simpler. However, this requires a change in habits and even mindset.
What is a financial cushion, and when is it useful?
A financial cushion represents savings that allow us to survive for up to several months when we lose our income. Its primary purpose is to provide financial security against unexpected expenses or events. This may be the loss of a job or the illness of one household member, which makes it impossible for that person to work or which even demands expensive medical treatment.
This financial solution allows us to have peace of mind during difficult times, knowing that we have the right back up in case of unexpected expenses. This is especially important now when many people in various industries lose their jobs overnight due to the coronavirus pandemic. The security fund is also helpful when a financial crisis or the company's bankruptcy we work for occurs. Thanks to it, we know that in case of problems we will have enough to cover our living expenses.
How much money should we have in our financial cushion?
The more money you have put aside for a rainy day, the better. In reality, however, many people find it challenging to save, so the minimum financial cushion should be 3 times our monthly expenses. This way, if we lose our job or are deprived of other sources of income, we will be able to survive living at a normal level for at least 3 months. This is a suitable time to look for another job or overcome other hardships.
Meanwhile, they say that a proper financial cushion should be 6 times our monthly expenses. Ideally, the financial buffer should allow us to survive for up to one year without any source of income.
By having a larger financial cushion, you'll have greater peace of mind and a softer landing when it comes to things like job loss or other unexpected events. However, it is worth remembering that one should take a monthly average of 12 months when calculating expenses. They are different during the holiday season and in the winter when we may incur additional costs such as heating or holiday preparations.
How do you create your own financial cushion?
To begin creating a financial cushion of your own, the first thing that needs to be done is to determine the amount. This should be an amount that will allow us to sleep soundly. Whether it will be 3 or 6 times the monthly expenses, it depends on how much restful sleep one wants to have.
When defining the amount of financial cushion, various scenarios should be taken into account - loss of job by one of the household members and serious illness or even breakdown of necessary household appliances.
The next step involves assuming the time in which we want to gather the fund. We need a realistic planning period in which we will be able to save money. Let's say it will be 3 years, so 36 months. We just have to divide the assumed amount by 36 to know how much we have to put aside every month for the planned goal.
Of course, what comes next is saving regularly and sticking to the plan. Warren Buffet's principle helps here, i.e. savings first, and only then obligations and pleasures. Therefore, it is worth having a regularly scheduled transfer in your bank right after payday to automatically transfer the money to, e.g., a savings account.
That way, it won't tempt us, and automating the process will eliminate any potential delay in doing so. Also, one should consider keeping a special account, even at another bank, dedicated just for a financial cushion. This way, we won't see the funds as often, and they won't tempt us.
Moreover, it's a good idea to allocate all additional and unexpected sources of income to the financial cushion. A bonus at work? Instead of buying a new TV, put that money into your financial cushion. The sooner we build it, the more secure and safe we will feel.
You can also look for other ideas to economize your budget. Consider, for example, resigning from daily coffee out in the city. On a monthly basis, this way, you can save a decent amount of money. Maybe you should also ask your boss for a raise and use the sum for savings?
When it comes to building a financial cushion, it is also helpful to analyze all of your expenses carefully and cut down on those that may be unnecessary. For example, you can assume that you do not spend more than 100 EUR a month eating out or on sweets. Sticking to such a plan will improve the creation of financial security.
Where to keep money from the financial cushion?
Funds that serve as financial security are best kept in a place separate from the rest of your money. It can even be a piggy bank, but a better solution will be, for example, a savings account or a deposit so that with rising inflation, our savings at least will not lose value.
Also, it is a good idea to separate the amount into several different places. If we already have a financial cushion built up, let's create a small emergency budget (e.g. 500 EUR) that will always be on hand. This is money meant for current, unexpected expenses.
Part of the sum (e.g. 2,000-3,000 EUR) should be used for larger, irregular expenses (e.g. car repairs). Such an amount can be kept, e.g., in a savings account, which allows withdrawal at least once a month.
The rest can be put, e.g., in a long-term deposit. When managing your financial cushion, it is worth remembering not to allocate it to uncertain investments. A financial cushion should serve as financial security and not as an opportunity to increase your wealth.