As you may have probably already know from my other articles, I am a security oriented guy. In my childhood, my family taught me the importance of savings as financial cushion and of a parsimonious life. As children sometimes do, I internalized these lessons and exaggerated the concept, spending (very little) money only for strictly necessary items or services, and often negating myself any kind of “costly” pleasure. I started investing money actively only in 2019, as until then I saw investing only as a way to quickly lose money.
Although it not always easy to cope with such a consolidated behavior, a pleasant side effect is that all the money I did not spend was accumulating on my bank account. Decades of savings paid off, at least financially, as I could suddenly dispose of a considerable amount.
This finding was quite a surprise, because several friends of mine were always struggling to find a balance between income and expenses – I lend some of them money up to 8.000 Euro at once – and since then I was just content that my financial situation was stable.
Observing the relationship my friends and other people I knew had with money, I can identify one big difference leading to the (financial) antithesis I was part of – and that you probably have already figured out. In the article “Keep track of your expenses“ I point out how important it is to know the balance between your income and your expenses, and how you use the knowledge you get from knowing how you spend your money to fine tune your expenses.
But what can you do with the money you save month after month?
Every month, I invest ca. 40% of my netto income in different fonds and ETFs, using the Broker App Scalable Capital (click here for more info*), as all saving plans are fee-free there.
Additionally, I put aside 10% of my netto income as a financial cushion.
Why do I need a financial cushion?
A financial cushion can be good for the mind, as I think it is never wrong to have a certain amount of money to help me in case I have any emergency or even for everyday things, as I don’t want to borrow money from someone or take a credit from a bank. That’s why I’m going to list what I think are the 5 most important reasons why I have a financial cushion – and why you should have too.
1. Financial independence
A certain amount of money means independence, for example from my job or my family. This means that having money in my savings account to keep my life running for the next six months, I don’t need to worry about a new economic crisis or another Covid pandemic lockdown. In other words, I have a safety net that catches me in difficult situations, so I can avoid major financial/existential fears.
2. focus on important topics
Maybe you have already experienced or know from acquaintances: The month hasn’t come to an end, but the money seems to being vanished and you have to scrape together all the leftovers to pay the bills left. Every penny has to be turned over twice before it can really be spent. Money is then drawing all your attention and you cannot focus on anything else. With a financial cushion, such emergency situations can be approached without fearing for your existence until your financial situation improves.
3. Increased psychological well-being
The financial security gained by having a financial cushion takes a big burden off my shoulders. The certainty of having enough money in the short term for the next few months strengthens my general sense of well-being and I am more relaxed.
4. one-off “unexpected” costs are covered
Sudden car repairs or any other major purchases, commonly known as “unexpected” costs, can be easily paid for with the help of your financial cushion. It is important to replenish the financial cushion after such an expense, so that you will be prepared as well for the next unexpected situation.
In the US, a often quoted survey of GOBankingRates shows that almost 70% of the respondents did not have more than 1,000 USD as a financial cushion in their savings account.
5. discipline in money management
A financial cushion strengthens discipline in dealing with money, as the discipline is not to touch this money and to use it only for emergencies. Many people find it difficult not to spend money when they have it just lying around in a bank account. Once you have learned how to build up a financial cushion, wealth accumulation is only half as difficult, as it follows the same principles.
How can I build a financial cushion?
Once that you have found your personal motivation to have a financial cushion, you will need to find out the causes keeping you from increasing the amount on your savings account.
For example, start to make saving money a priority. You shouldn’t wait until the end of the month to see how much money you have left to save. Instead, create a budget and put saving money at the top of your list of most important expenses. To determine how much you can set aside, add up the expenses you need to pay and determine which non-essential expenses you can cut to make more room in your budget to save. In case you don’t know where to start, I suggest you read the article about tracking your expenses.
Automate savings. To make sure you are saving money, ask your workplace HR department to deposit a portion of each paycheck directly into a savings account, or create a standing order to transfer the money amount from your main bank account into a savings account . This approach can work for even the worst savers.
You can then also find someone to hold you accountable. Being accountable for your goals is not something everyone can do for themselves. Scientific studies show that you are more likely to succeed if you get positive support and encouragement from other people. Share your savings goals with a friend or family member, or request the help of a professional, like a wealth adviser, your coach etc.
Final thoughts
A strong motivation is essential to start building a financial cushion, as with it in mind, you will always have a good reason to keep going.
What are your suggestions for having a financial cushion and maintaining a savings account?
