Studies have shown that almost half of Americans live paycheck to paycheck, sadly even worse now due to COVID. I am not an anxious person. But THAT right there or the notion that every dollar you earn is already assigned to an expenditure – makes me anxious. It is so important to build up a peace of mind account, an emergency fund, an Oh shit account, a What if account I don’t care what you call it but I highly suggest you have it. Especially if you are a homeowner or have children.
What is a Peace of Mind Account and Why Do You Need It?
Well, put simply….peace of mind. A POM account is interchangeable with what others deem an Emergency Fund. But when I hear Emergency Fund I see red lights flashing and hear sirens going off and I just don’t need that kind of negativity when I think about my money, am I right?! Ergo, peace of mind account.
A POM account’s primary purpose is for money to be set aside and earmarked for significant, unexpected expenses. The goal in funding this account is so that you don’t have to constantly stress about how to pay for this appliance that broke or that medical bill. Or having to think, how will I ever get ahead?
You will have the funds to pay for the inevitable surprises that arise without having to directly impact your lifestyle or your future financial goals. Sigh…yes, that sounds fantastic doesn’t it?
It is easy to get wrapped up in the day to day, swiping our credit cards without any sort of accountability and trying to keep up with the world around us. But this willy nilly “strategy” will not win over time and the only person who will hurt from it – will be you.
I want you to succeed and be financially secure, financially free and not constantly feeling financial pressure. Spending every single dime that comes in and not tucking any away for safe keeping is not going to be the way.
How Much Do You Save in Your Peace of Mind Account?
This is a personal number but as a baseline suggestion – your overarching savings goal should be to save roughly 20% of your after tax income each year. More specifically, your POM account should have roughly 3-5 months worth of monthly expenses saved.
This number is not meant to overwhelm you, scare you off or for you to get a good laugh. This should become a very realistic number. It may take some spending adjustments, a change in your money habits or a good cold glass of water to the face but this is a solid, achievable goal. I have faith that you will make it so.
Side Note: If you have high balances in your credit card account or other high interest bearing loan balances – then my suggestion would be to focus more of your energy on paying those down before looking to bulk up multiple savings and investment accounts. Tune in to a future blog post coming soon discussing my thoughts on debt.
Let’s look at an example….
For purposes of this example let’s consider you do not have any substantial credit card or student loan debt and you have nothing currently saved in your peace of mind account. As a result, a combination of 401K contributions and building up a POM account should be the highest priority.
- You make $100,000 per year. (Take home pay is $70,000 per year after assumed 30% tax)
- Your company match is 5% into a traditional 401K plan
- You spend roughly $4,500 per month (Based on my history in the industry, it is typical for someone to spend anywhere between 75-85% of their after tax income on average)
- Saving 20% of after tax income or $14,000 per year between your 401K & POM account
- Saving roughly 3-5 months worth of expenses in a POM account
- Contributing up to the match of your employer sponsored 401K
- You contribute a minimum of 5% pre tax income or $5,000 to your employer 401K plan because in return you essentially receive free money from your employer through their 5% company match policy. Your take home pay after taxes and contributing to 401K will be roughly $66,500 or $5,500 per month. You’ve already accomplished saving $5,000 pre tax (7% of your 20% after tax annual savings goal) into your retirement account. Well done!
- Plan to automatically transfer the remainder $9,000 or 13% of savings goal into your POM account. This is roughly $750 per month or $375 per pay period. Automate this step. Create a strategy – once a month or every pay period, whatever works for you. But automate this step so it doesn’t leave you any room to come up with a reason to change your mind.
- Based on your $4,500 monthly spend, you would need between $15,000 – $20,000 in your POM account to satisfy the 3-5 months saving suggestion. Currently, it would take you anywhere between 18 – 24 months to fully fund your peace of mind account.
On the road to six figures….
Here is another fun way of looking at it. If you kept up this strategy for 5 years… let’s assume you never got a raise, never increased your contributions to your 401K and never invested any of it (this is pretty unrealistic that any of these three things would happen BUT…let’s continue).
So you saved $5,000 per year into your 401K, you received $5,000 from your employer per the 5% match and you saved an additional $9,000 into your POM account annually. After 5 short years you would have approximately $100,000 saved. Bada bing bada boom. Now imagine if you had invested that 401K!
How Do You Prepare for Building Up Your Peace of Mind Account?
- Get a handle on your monthly expenses, cut out the expendables and learn to live on a little less.
- Identify the number you need in your POM account to help you sleep a little better at night. My suggestion is to save anywhere between 3-5 months worth of your monthly expenses.
- Create an achievable goal for how much you would like to save on a monthly basis that is going to help you fund your POM account.
- After creating the goal, get a strategy in place for how you expect to accomplish it. What habits will you create or change to help you achieve this goal. Review my Top 5 Ways to Build Smart Money Habits as a starting point.
- Stay CONSISTENT!! Remember, the decisions you are making today are going to have an impact on your tomorrow.
You Can Do It!
The quicker you are able to set aside funds for emergencies or unwanted surprises the quicker you will be able to focus your efforts and energy on more aggressive ways to build your wealth.
And when you’ve reached your goal and your Peace of Mind account is fully funded….
Celebrate you with a glass of prosecco, feel incredibly proud and applaud yourself knowing that this is just the beginning of your financial journey!
And then what? WE DANCE!! I mean invest…yes yes we invest 😉