Financial safety nets are the key tool preventing you from calling prey to debt when something unexpected suddenly requires you to spend more than your monthly paychecks normally allow. Safety nets are the main idea behind the very first pillar, Prepare, of our 4P Budget system, so we’ll go deep into the different types and qualities of safety nets, and how to build a great one for your own life and family.
Not all safety nets are created equal! Imagine evaluating each financial safety net on two different axes. On the horizontal axis, you would rate the net’s sustainability, whether you can stay in that net for a long time or just short time. And on the vertical axis, you would look at how healthy or unhealthy safety is. Think of “healthy” as a safety net where you would want to stay a long time, and unhealthy as a safety net where you wouldn’t want to stay long time, even if it were actually sustainable.
Together, these two axes divide a diagram into four quadrants, as I’ve done in the image below:
Now let’s dive into each of the four quadrants and talk about the safety nets in each. Hint: you really want to get quadrant two as fast as possible, and stay there for the rest of your life.
Quadrant 1: Healthy, but unsustainable
If you’re just starting out with no safety net and haven’t yet run into a huge calamity that wrecked your monthly income and spending, you can begin building a healthy safety net for the short-term. Many of you are lucky enough to have a healthy safety net already: parents, grandparents, other family members, or friends. If you lost your job tomorrow and couldn’t pay the rent, could you move back in with your parents? Could your spouse or roommate let you slide on your portion of the bills for a few months? Maybe spend a few months in the spare bedroom of that really successful cousin?
These are amazing, beautiful safety nets, but you can quickly guess why I’m listing them as “short term” and “unstainable.” You’ll wear out your welcome, possibly very quickly, if you become a drag on your friends, family, and neighbors. But early in your career, it’s a good start. For an option that’s viable in the long-term, let’s look toward Quadrant 2, below.
Quadrant 2: Healthy, even for the long term
Having family members or friends you can depend on is great, a true blessing. You should always, 100% maintain the types of relationships that allow you to rely on them. Also: be there for them when they need your support because they have their own crisis and need a safety net!
However, these Quadrant 1 safety nets shouldn’t be Plan A. Instead, you should create your own safety net in the form of a liquidity fund, that is, cash or other investments you can “liquify” into cash on short notice. Many people call this an emergency fund, but I find this confusing since most “emergencies” are really things you should be planning for instead of reacting to. Regardless of your name for this fund, the amount of money to set aside where standard budgeting advice gets confusing. Many programs recommend “an emergency fund of 3 to 6 months of expenses” as a blanket statement, but this rule of th
As an example, imagine you’re a successful executive in a sweet role making a great salary. But, out of nowhere, your company suddenly has an accounting scandal and lays-off 60%! How long will it take you to get a new job? Replacing that high-paying job in a specialized market may take much longer than 6 months, especially if you’re explaining why you’re not personally to blame for the fall of the next Enron or Theranos.
To maintain your lifestyle, you may need funds equivalent to one or two years of expenses in this scenario, especially if the trauma of your former job and its demise has taken a severe toll on your mental, physical, or relationship health. If you have a liquidity fund prepared, you can relax, recover, reskill, then find an even better job.
On the opposite end, when you’re just starting or restarting your financial journey, even a mere 3 months of expenses seems like a ridiculously hard goal, especially when you’re loaded up with student loans or credit card debt. Thus, my recommendation is to hold one month of minimum expenses in liquid funds for every year you’ve been an adult.
So if you’re 30 and have been working for 8 years, try to have 8 months of essential expenses (not salary, just bare-minimum expenses). As you grow older, this liquidity fund needs to grow quite a bit larger because you have kids and more cars and a bigger house, so after twenty years, consider keeping 20 months.
When you hit 30 to 40 years of career, the beautiful part about this liquidity fund is that it’s accessible, without taxes or penalties, before any of your tax-deferred investments. Want to retire at age 55 instead of 59 1/2 (the age you can access your IRAs and 401(k) funds)? Use your liquidity fund—now totaling 33 of months of expenses since you’ve been working since age 22—as a glide path until you can start pulling from qualified retirement accounts.
Realistically you don’t want to keep all this money in cash, either. If you’re keeping three years of expenses, you won’t need it all at once—it should take you at least 36 months to consume, possibly far longer if you decide to stretch it out. Therefore you can keep some actual cash equivalents (like in a short-term CD or high-yield savings account) in a “hot” tier, some in a “warm” tier like a long-term CD or CD ladder, and some in a cold tier like in a taxable brokerage account with some low volatility stocks. These three tiers will allow you to earn money and invest your liquidity fund while still keeping it available.
Note that this fund doesn’t have to be all for unexpected expenses—it could be money you’re saving for a car, or appliances, remodeling, or optional things like vacation, or anything you’d allocate for ahead of time in our Predict pillar. The point is that you won’t have to take out debt or disrupt your normal monthly budget items to handle these random events.
This liquidity fund might be a long journey! Until you build a long enough runway for your fund, you’ll need to have another safety net, a second stage when you fall too far or too fast for your monetary net. Get together with your closest relations or allies, your friends, your tribe, and agree together how to support each other when one of you is building up reserves, essentially using a non-monetary Quadrant 1 net when you’re not yet fully funded with your own money for Quadrant 2.
The final two healthy nets: insurance policies and retirement
Even when you have a liquidity fund that’s appropriate to your stage of life or career situation, there are disasters so big that you’ll never be able to save enough on your own. That’s where insurance comes in—it’s the safety net for your safety net, where to land when there’s no other alternative. You’ll need health insurance, life insurance, umbrella insurance, and maybe a few other special types specifically for your stage of life and risk tolerance. We cover how to choose a policy and answer a ton of insurance questions in this article: (coming soon).
Finally, there’s a special type of safety net when you’re no longer able to work: retirement. This one needs to be sustainable for 30, 35, maybe even 40 years! You’ll need some combination of savings, investments, government plans or pensions, or even part-time work to let your body relax and enable you to contribute to society in ways other than your daily wages. That’s covered in Pillar 4, Provide.
Maybe you’ve always wanted to write, or be a counselor, or teach high school chemistry, or just take care of your grandkids. Retirement, or even semi-retirement, is the place you can do just that, but only if you’ve saved enough during your earning years to have financial freedom later on. The point is that you may be even busier than you were during employment (but hopefully less stressed) and your retirement safety net needs to be strong enough to let you bounce around as you explore what life is like without a regular paycheck.
Quadrant 3: Unhealthy, but sustainable for a while
Here’s where you live if you constantly let your expenses exceed your income. Quadrant 3 is a vicious cycle of “get into debt → pay it off → don’t fix the underlying problem → get into more debt.” You’re living so close to the edge that you never prepare an adequate safety net, so you turn to credit cards, payday loans, “buy now, pay later” schemes, and other high-interest forms of debt or usury.
In this loan-laden quadrant it’s very tempting to borrow money from people you know as well, which can easily destroy the relationships you might depend on for Quadrant 1. If you’re still employed while in this quadrant, you might be able to sustain the misery of paying 20%+ interest for years or even decades, but you won’t be happy about it. We talk about a “consumption economy” when people buy stuff and consume, but I think the stuff is actually consuming us if we bought it with debt and suffer the anxiety of never paying it off.
The real danger of being in Quadrant 3 is that while you know it’s unhealthy, it appears to be sustainable. You may get away with it for years as you cycle through periods of feast and famine. But while your expenses exceed your income, you’ll be paying ridiculous amounts of interest that could be used for something much better! Instead, you should be building your emergency fund, buying a house, or saving for the long-term (the Provide pillar).
Quadrant 4: Unhealthy and unsustainable
We just looked at Quadrant 3 and said it was only sustainable while you were employed. When you lose your job or have some other major disaster like an accident or uninsured loss, your debts can quickly become overwhelming and you’ve got no credit options left to make up the widening gap between your income and daily necessities.
Before you’ve built up an emergency fund, or if you’ve depleted it, there’s hopefully a Quadrant 1 relationship with family or friends you can rely on to give you a warm place to sleep until you get back on your feet. However, if you’ve exhausted Quadrant 1 and Quadrant 2 options, there aren’t a lot of alternatives left. You’re going to hit rock-bottom and be at the mercy of government assistance programs, or, when you get kicked out of your dwelling, you’ll have to depend on homeless shelters and other rescue programs.
These Quadrant 4 safety nets, while good intentioned, will eat you alive. It becomes mentally, physically, and emotionally excruciating to get back out of this quadrant if you’re unemployed, homeless, and quite possibly deadening your pain with drugs and alcohol. Avoid these types of safety nets at all costs.
The biggest dilemma: how to balance debt and wants with far future savings
Which do you do first after you’ve prepared your Quadrant 2 safety net but still have some debt to pay off? You have have extra income after your necessary expenses, so does it all go toward debt? Or should you have some fun? Or maybe save for the far future? Here are the main options, which you can choose between depending on your level of discipline, risk-tolerance, and emotional relationship with money.
Option one: Spartan Honey Badger
If you’ve ever seen a video of a honey badger or live at the zoo, you were certainly impressed by their relentless ferocity. The soldiers of ancient Sparta also live with the same intensity, and their lifestyle came to be associated with austerity and simple living that should work well in this phase of your life.
Repaying your debt like a Spartan Honey Badger means avoiding all non-essentials, including long-term savings, until you’re out of debt. The most extreme adherents here will even demand a fully-paid-for house before saving for other stuff. If you’ve seen your parents or family get consumed by predatory loans, let this experience motivate you to get out of debt as fast as possible. Channel that passion into the sacrifices necessary to put every penny towards freedom.
Human psychology works in your favor here as well; after the initial shock of deprivation, it turns out your happiness will naturally rebound as you adjust to your new disciplined lifestyle. Your reward is the shortest possible duration of misery as you can quickly retire even large debts in just a few years.
Option two: Disciplined Beaver
Beavers never stop working! But they take their time as well. There’s none of the frenetic, fearless risk-taking that characterizes a honey badger. Instead, beavers work their plan at an even pace and gradually build impressive dams. You can do the same by being smart about saving in tax-advantaged accounts while also paying off debt.
Getting the ratio of debt-reduction to future savings should be a simple matter of math. If you’re paying off high-interest credit cards, you should barely put any money toward long-term savings. If you’ve paid down or consolidated those loans and just have student loans with manageable interest, consider splitting your excess income evenly between extra mortgage principal payments, student loans, and tax-advantaged retirement accounts. The immediate tax-savings alone can justify the extra interest you’ll pay on your debts, and the long-term compounding and tax-deferred growth are extra incentives to begin these savings plans even while you’re paying off current loans.
Interrupting Savings to Replenish the Safety Net
At this point, the only interruption I can foresee to your plan for far-future savings is when you have a big, unexpected bill and need to rely on your liquidity fund as a safety net. Both badgers and beavers will face these problems. If, for example, you had a car accident and now need to pay both your car insurance deductible and out-of-pocket maximum on your health insurance, you’ll probably have enough in your liquidity fund. But now that fund is partially (mostly?) depleted!
Until this fund is fully refilled, it’s time to suspend all the items in your discretionary “Prevent” pillar and, if needed, cut back or eliminate long-term savings contributions to the Provide pillar as well. What people forget is that budgets aren’t static, boring, and rigid. They have to adapt to the randomness of life! You were saving in the Provide pillar and spending in the Prevent pillar, but now you need to stop both of those pillars to instead refill and replenish the Prepare pillar. The good news is that it shouldn’t take more than a few months to top off the short-term safety net funds and get back to your normal money plan.