What Is A Financial Safety Net? And Why Is It Important?

By Zach Buchenau

Last Updated: June 12, 2022

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You’ve probably heard the term “financial safety net” before, but what does it actually mean?

A financial safety net is a cushion of savings, insurance, and other assets that you can fall back on in case of an emergency. Whether it be an unexpected medical bill, a sudden home repair, or a family emergency, a financial safety net can help you cover the costs without going into debt.

Ultimately, a financial safety net is a preemptive solution to unforeseen financial setbacks.

Why Is A Financial Safety Net Important?

A financial safety net can help you avoid debt and the associated interest payments and potential late fees. In addition, having a financial safety net can give you peace of mind knowing that you’re prepared for whatever life throws your way.

Since it’s not always possible to avoid financial emergencies, having a financial safety net can help reduce the stress and anxiety that comes with them.

Without a healthy reserve of savings, you may be forced to rely on credit cards or loans to pay for an unforeseen emergency–which can be difficult, expensive, and time-consuming to pay off.

And let’s be honest, when you’re dealing with any kind of financial emergency, the burden of debt is the last thing you need.

See also: Why Is An Emergency Fund Important? 7 Key Reasons

How Much Savings Should You Have In Your Financial Safety Net?

In terms of liquid savings, most experts recommend keeping enough money in your financial safety net to cover at least 3-6 months’ worth of living expenses. This will help ensure that you can cover your essential costs if you experience a loss of income or a large, unexpected expense.

This kind of savings is often referred to as an “Emergency Fund” or “Rainy Day Fund,” and it is the most basic form of a financial safety net.

Of course, the amount you’ll need to save will vary depending on your individual circumstances. If you’re the sole breadwinner for your family, for example, you’ll likely want to save more than a family with multiple sources of income.

The important thing is to start saving as soon as possible and prioritize building up your financial safety net. The sooner you develop a rainy day fund, the easier your financial life will be in the event of an emergency.

If you’re not sure how much you should be saving, consider talking to a financial advisor. They can help you create a personalized savings plan that takes your unique circumstances into account.

See Also: How Long Should It Take To Build An Emergency Fund?

Where To Keep Your Safety Net Savings

While a financial safety net can include more assets than liquid savings, a fully-funded emergency fund is the most important place to start.

But where should you keep your financial safety net savings?

In short, you should keep your safety net in a savings account dedicated solely to financial emergencies. Ideally, this savings account should be easily accessible in the event of an emergency, yet inconvenient enough to limit your temptation to spend it.

What is a financial safety net? And why is it important? | Be The Budget

If possible, you should look for an account that earns a decent interest rate.

No, a savings account isn’t going to make you rich, but it’s still nice to know that your money is growing a little bit while it’s just sitting there.

If you’re looking for a couple of good banking options for your financial safety net savings, we recommend CIT Bank and Axos Bank.

See Also: Best (And Worst) Places To Keep An Emergency Fund

Other Assets To Include In Your Safety Net

As we mentioned earlier, your financial safety net can (and should) include more than just cash savings. In fact, most experts recommend including a variety of different assets in your safety net.

What kind of assets, you ask?

Here are a few ideas you should consider:

Medical/Health Insurance

No one is immune to illness or injury, so it’s important to have health insurance in place to help cover the costs of medical care.

Seriously, uninsured medical bills are outrageously expensive–and health insurance can save you from financial ruin in the event of a major health crisis.

If you don’t get health insurance through your employer, I highly recommend looking into private health insurance options.

I realize that this isn’t a very exciting purchase, but you don’t want to be caught without it in the event of a medical emergency.

Term Life Insurance

If you have a spouse or children, term life insurance can help ensure that they are taken care of financially if something happens to you.

Once again, this isn’t a very fun subject to discuss. I mean, who really wants to spend their time focusing on their own death?

But this can be one of the biggest blessings you give to your loved ones.

The good news is that term life insurance isn’t very expensive. Depending on a variety of factors like your age, health, and occupation, term life insurance can cost as little as a $15 per month!

How much term life insurance coverage should you have?

Most experts recommend carrying at least a 15-year term life insurance policy equal to 10X – 12X your gross annual income. For example, if you make $50,000 per year, you should purchase a term-life insurance policy worth between $500,000 and $600,000.

Disability Insurance

Disability insurance is similar to life insurance in that it provides financial protection for you and your family in the event that you become disabled and can no longer work.

While most employers offer some form of disability insurance, this coverage is often not enough to protect your family financially if you become disabled.

That’s why it’s a good idea to supplement with your own personal policy.

Like term life insurance, disability insurance isn’t very expensive. And considering the protection and security it provides, this can be a great addition to your financial safety net.

Homeowners/Renters Insurance

If you own a home, you should have homeowners insurance to protect your property in the event of damage or theft.

And even if you don’t own a home, you should still consider renters insurance to protect your belongings.

There’s just no reason to take unnecessary risks when it comes to your property.

Plus, homeowners and renters insurance are relatively inexpensive, so there’s really no excuse to not to have this coverage in place.

Additional Tips For Developing A Strong Financial Safety Net

In addition to the asset protection strategies we’ve discussed, there are a few other things you can do to make sure your financial safety net is as strong as possible.

Here are a few final tips:

Live On A Budget

One of the most critical things you can do for your finances is to live on a budget.

Not only will budgeting help you save for emergencies, but it will also help you navigate any unexpected financial surprises or irregular expenses.

When you know where your money is going each month, it’s much easier to save money and make wise financial decisions.

See Also: Why Is Budgeting Important? 10 Key Benefits

Live Below Your Means

If you want to be financially secure, it’s important to live below your means. In other words, you need to learn to live on less than you make.

I know this is easier said than done, but it’s really the key to financial success.

By cutting your expenses and creating some financial margin in your life, you’ll have room to save for emergencies, invest for the future, and build wealth.

See Also: 9 Benefits Of Living Below Your Means

Develop Multiple Streams Of Income

One of the best ways to bolster your financial safety net is to develop multiple streams of income.

That way, if one stream dries up, you’ll still have others to fall back on.

There are a variety of ways to generate additional income streams. You could start a side hustle, invest, or even get a second job.

Regardless of the method you choose, diversifying your income can greatly improve your long-term financial security.

Invest For Retirement

Another highly-important step you can take for your financial future is to start investing for retirement as early as possible.

I know it may seem like retirement is a long way off, but it will be here before you know it.

The sooner you start investing, the more time your money will have to grow. And the more your money grows, the less problematic financial emergencies will become.

To be clear, using your retirement investments to pay for an emergency should be an absolute last resort. The point of retirement investing is to create a nest egg that you can live off of in retirement.

But if you find yourself in a situation where you have no other choice, it’s nice to know that your retirement savings can act as a financial safety net.

Retirement investing can include a variety of different strategies, but two of the simplest and most effective ways to invest for retirement is to contribute to a 401k and/or a Roth IRA.

Oh, and if your employer offers a 401k match, be sure to take advantage of it! This is free money that can really add up over time.

See Also: Top 10 Reasons To Start Investing Early

Final Thoughts

A financial safety net is an important part of any sound financial plan.

It can help you weather unexpected financial storms and protect your family in the event of an emergency.

While it isn’t fun to dwell on worst case scenarios, it is important to be prepared for them. Fortunately, once you develop a solid financial safety net, you’ll be able to live without the fear of financial uncertainty, and operate from a position of financial confidence and strength.

Zach Buchenau

About The Author:

Zach Buchenau is a self-proclaimed personal finance nerd. When he isn't writing about budgeting, getting out of debt, making extra money, and living a frugal life, you can find him building furniture, fly fishing, or developing websites. He is the co-founder of BeTheBudget, and Chipotle's most loyal customer.

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