Saving with a financial cushion can give you a sense of security. This is especially important nowadays, when so many people are struggling with an uncertain financial situation. Some even in crisis. Do you want to know how to build a financial cushion? How much should it be? Is it worth building your own financial cushion?
What is a financial cushion?
A financial cushion is a type of savings that can be very useful in various types of emergency situations. The money from such a cushion is usually treated as a reserve in case you need the money immediately. Thanks to this, you will be able to spend it on any unexpected expenses, including larger ones.
It also serves as security in the event of job loss. Such a reserve of money can be useful in many situations for which you are not prepared at a given moment. This may be, for example, a car repair or an urgent visit to the doctor.
Having a financial cushion will also help you avoid debt and loss of financial stability.
Financial cushion – reasons why it is worth having it
Having your own financial cushion brings many benefits, e.g.:
- you don’t have to worry about unexpected expenses that may arise at any time,
- a financial cushion will protect you from debts,
- you will gain a better quality of life,
- will be your protection in the event of loss of regular income,
- you will approach irregular expenses with greater peace of mind, e.g. the purchase of a new refrigerator or washing machine, and at the same time avoid debt in the form of a loan,
- having a financial cushion is a good start to investing.
What else is worth remembering? It is important to replenish your financial cushion regularly. This will help you feel confident that you are prepared for unexpected expenses or loss of income. You can also consider investing your financial cushion in safe investment products. This way, you will increase its value thanks to the accumulated interest.
Do you need help with saving or planning your expenses? Then first check out the entries below:
How to build a financial cushion – where to start?
You probably already know that building a financial cushion is a process that requires patience and discipline. However, over time, your savings will grow. This will give you greater peace of mind in the event of sudden expenses or unexpected changes in your financial situation. So where to start putting some money aside for a financial cushion?
- Analyze your financial situation.
- Choose a goal and plan a strategy.
- Save and put aside all your surplus.
- Reduce all expenses.
- Find an additional source of income if you can afford it.
- Monitor your finances and be open to making changes while building your financial cushion.
Financial cushion – how much should it be worth?
We may disappoint you, but this question cannot be answered clearly. A lot depends on your financial situation, lifestyle and individual needs and preferences. Moreover, it is worth looking at it from a different perspective, i.e. considering what it would protect you against. Of course, it will not be easy, because we cannot predict the future, but we do it as an estimate.
We calculate the amount of such savings based on our monthly expenses. This means that for several months you should monitor and note down how much money you spend each month. Thanks to this, you will be able to calculate the average monthly value of your expenses. In fact, you will get a full picture if you analyze it throughout the year.
Financial advisors usually recommend that the financial cushion be worth 3 or 6 months of expenses. However, 3 months is the minimum value. The safest thing would be to prepare for 12 months of expenses. If you are an entrepreneur or self-employed, it is worth considering a longer period. The idea is that in such cases, your income may be more unstable.
Having saved up money equal to your annual expenses, you can easily start investing your assets. Of course, I’m talking about some of them here, because you need to be prepared if something happens.
However, remember that this is a very individual matter. This may vary in each case. It is important that you adjust the value of such a pillow to your needs. If you live alone, it is obvious that you will have completely different expenses and needs than, for example, a family of 4.
How to build a financial cushion?
Let’s start with the fact that every person should have a financial cushion. However, it should be borne in mind that building a financial cushion is a process that is best broken down over a longer period of time. Thanks to this, we will avoid excessive strain on the household budget.
Do you feel that building a financial cushion will be too much for you? Don’t give up so quickly because it’s not as complicated as it may seem. You will have to put in the effort because, as it happens in life, a financial cushion will not appear out of nowhere. You have to work for it yourself.
It is worth realizing that building a financial cushion is an important step towards ensuring financial stability for the future. We’ll discuss how you can approach this later in this article. Remember that this is only one possible option – another may work in your case.
Determining the amount you want to accumulate on your financial cushion
You need to start by determining the amount you want to ultimately accumulate as a financial cushion. It is important that it is not an excessively low amount, but one that seems safe to you. Safe, i.e. one that will ensure your survival if your main source of income disappears.
To do this, it’s best to analyze how much money you spend each month. Your home budget will certainly be useful, but we realize that not everyone keeps one. In such a situation, you simply need to estimate an approximate amount. Imagine the different possibilities of what could happen. If you look at it specifically, it will be easier for you to estimate the amount.
Some people think that if they earn little, they have nothing to save for this purpose. Looking at it from a logical point of view – there will always be a way to save even small amounts. The amount of the emergency fund simply needs to be adjusted according to your earnings and expenses. You’ll thank yourself for it later.
Plan how long it will take you to raise money
It is very important that you set a time that is realistic, i.e. achievable. There is no point in fooling yourself that you will collect the entire amount in 3 months. Especially when it is large. You still stick to the specific amount mentioned in the point above.
We move on to the stage when we need to make the necessary calculations. You need to know how much money you should save each month. How to do it? It’s quite simple – you write down the amount you want to accumulate on the cushion and then divide it by the number of months for which you will accumulate it.
Let’s give an example to better illustrate this. Let’s assume that you plan to collect PLN 30,000 and you give yourself 5 years to do so. So we have the following effect: 30,000:60=500. It looks like you need to save PLN 500 a month.
Of course, it may happen that your finances will get better and better. Then you will be able to save the agreed amount earlier than you planned.
Automation, i.e. cyclical transfers
It is good practice to use the so-called cyclical transfers. The idea is that the agreed amount is regularly transferred to the savings account, without your intervention.
It is important that they are implemented immediately after the salary is credited to the account. When we say “right after” we mean the same day. Thanks to this, we will avoid postponing it for later or even forgetting about the transfer.
Automatic transfers are set up in your bank, you can probably even do it using a mobile app.
Financial surplus = shorter time to build a financial cushion
If you have even a small financial surplus, transfer money to your pillow. We have already mentioned that it is possible to collect funds for a “rainy day” in a shorter time than you expected. This is great news, especially if you can achieve this with your initial plans.
So don’t miss any opportunity – no matter if it’s a bonus at work or you simply managed to live more frugally this month. If at the end of the month you have some amount of money that should be spent as planned, do not hesitate and simply transfer it to your savings account. It is possible that this way you will be able to significantly shorten the time needed to build your safety cushion.
It is also worth thinking about changing your financial habits – one of them is avoiding expensive purchases. Similarly, treat any purchases that are not necessary at that moment.
Financial safety cushion – where to keep your funds?
We have already discussed the issue of how to build a financial cushion. However, in the context of a financial safety cushion, other questions often arise.
One of them concerns where to store the accumulated funds. That’s why we have prepared a short list of possibilities. The key is that the financial cushion is set aside for any emergency situations, so it is a very important aspect that it is also easily accessible when such a situation occurs. The idea is that you can use this money quickly if something unexpected happens.
The available options for storing your financial cushion include:
- deposits – allow you to keep a certain amount of money in the bank for a certain period of time, also fixed. There are different types of deposits, the length of which ranges from several months to several years. At the end of the deposit period, we receive the interest that was accumulated during the deposit. How many there will be depends on the interest rate we have chosen. The disadvantage of this form of savings is that you cannot change the money you deposit at the beginning. This applies to both increasing this amount and selecting part of it,
- savings accounts – a convenient option that makes saving easier. It works similarly to a deposit, except that here we have access to our money, so we can, for example, regularly top up such an account. We also have the option of withdrawing funds earlier,
- IKE/IKZE – i.e. Individual Retirement Account and Individual Retirement Security Account. Participation in them is not obligatory. Moreover, the funds you accumulate there can only be withdrawn when you retire (they occur in Poland),
- investments – the least safe option (compared to the previous ones). It is true that you can gain more this way than with the previously mentioned options, but it involves risk. It is possible to lose part of the amount or even the entire amount. In the case of investments, it is best to seek help from a financial advisor.
Are you looking for ideas on how to save money? Check out our previous posts:
We hope that after reading this entry, you now know how to build a financial cushion. What can having a financial cushion give you? First of all, it will help you feel safe even in unexpected situations.
You must remember that building a financial cushion is a long-term process that requires regular saving and patience. The sooner you start building your financial cushion, the better.