An emergency fund is an essential part of any financial plan. You never know when the unexpected will unexpectedly happen and will knock you for a loop. It is imperative that you have some finds set aside for a “rainy day”.
An emergency fund is important because, in the event you do face an emergency, you will need to be prepared with an easily accessible account large enough to cover your expenses and get you through this tough time.
Here is a simple 7 step guide to starting and building your emergency fund.
1. Decide how much your emergency fund will be.
The first decision you need to make is how much money you will have in your emergency fund. Most financial experts will tell you your emergency fund should be large enough to cover anywhere from 6 months to a year of expenses.
There really is no right or wrong answer to this question. It is entirely up to you and what your comfort level is. Do you want to have your entire monthly expenses covered for a year in case you get laid off? Then aim for a year’s worth of expenses saved. Perhaps you feel very secure that your current income level will remain constant for a long time and decide to only have 3 months covered, that is ok to. I personally would not go with any less than 6 months but that is my comfort level.
The important thing is that you have calculated your regular expenses and income and come to an educated decision on what is right for you. Once you do, write down the dollar amount and hang it up on the fridge or somewhere you will see it every day to remind you of your goal.
2. How long should it take to fund
The 2nd step towards achieving any goal is giving it a time limit. What is your deadline for achieving this goal. Famous author Napoleon Hill said “A goal without a deadline is just a wish”. His book, Think and Grow Rich is a landmark in the personal finance world. If you are interested in checking it out, here is my affiliate link to amazon.
Putting a time limit on this goal should be an easy task. You have already determined what your monthly expenses are and you know what your income is. It is simply a matter now of, how much can I realistically save each week/month towards my emergency fund.
You might need to look at making some sacrifices to get there. Maybe you cancel cable or drive a used car for a while. But you need to determine an exact dollar amount you will set aside each month. Then simply do the math to determine how long it will take to reach the finish line.
Here is an example of someone with a goal of $20,000 for their emergency fund. They determine they can save $1000 a month, therefor it will take 20 months to reach their goal.
The simple formula is total goal divided by monthly savings equals months it will take to reach goal.
3. Set smaller goals along the way
Large goals are more easily achieved by setting smaller goals along the way. No dieter ever lost 100lbs without first losing 5 lbs, then 10 lbs, then 20 and 50 and so on. If you set a goal to large, the odds are more likely that you will quit before achieving it. You should break your large goal down in to smaller goals.
So for the example above where you are looking to save $20,000 in 20 months, I would have monthly and even weekly goals. You might start out ridiculously tiny with something like, I am going to save all of my spare change and have $5 extra this week. Or I will stop drinking coffee and save an extra $15 a week.
This is a long journey you are on and you will need to take it day by day, step by step. You can not leap your way to a $20,000 emergency find unless of coarse you win the lottery, inherit $20,000 or have one hell of an income that you can save $20,000 in one step. (If that is the case, a. you don’t need a plan and b. please let me know if they are hiring)
The point is, take it slow, break your large goal down into smaller, more achievable goals and earn a sense of accomplishment each time yo reach a milestone. Your ultimate goal will be much easier to achieve this way.
4. Pay yourself first
Unless this is your first time reading my work, this is nothing new to you. I am a huge advocate of paying yourself first no matter what. Weather you are saving for an emergency fund, retirement, or for a shiny new bike. If you do not pay yourself first, you will not pay yourself ever.
The tax man is the smartest man alive. He has set it up so that he gets paid before you even get to sniff your income. Imagine if he decided to take another $1000 a month. What would you do? You would pay it and figure out how to live off of what is left. So why not do yourself a favor and just pay yourself that money first and learn to live off what is left.
I failed to pay myself first for a long time and I came to regret it later. I finally came to my senses on this and I currently reap the rewards with not only a healthy emergency fund but a well funded retirement nest egg. Trust me, the money is there, you simply need to commit.
If you need help understanding why you are broke or what you can do to stop wasting money and start paying yourself first instead, check out these 2 articles.
Lifestyle Creep prevention methods that actually work
10 insanely easy ways to cut spending and become a millionaire by 45
5. Automate
The easiest way I have found to pay yourself first is to simply automate your deposit into an account that is not your regular every day account. So for example, I get paid every other week. My paycheck gets direct deposited into 2 different accounts. My every day account that my wife and I use to pay monthly expenses and a portion goes directly towards my retirement nest egg account. She has her check split into 3 different accounts.
The reason we do this is to eliminate the temptation of spending the money before we have a chance to save it. If all of your money is in one account, and you use that account to spend, chances are the money will be spent. But if you earmark different accounts for different purposes, then those accounts will be used as intended.
We have an account for our emergency fund, one for retirement nest egg, one for our annual property taxes, one for vacations and other fun stuff, and one for our regular every day budget. We also have other accounts that we have opened just as additional savings accounts.
For example, our acorns account that is accumulating money for us that right now has no purpose other than to accumulate fund. This might be our Christmas gift fund. We haven’t decided yet. But the account is growing rapidly and right now we don’t even think about that money because it just automatically happens. If you want to learn more about acorns, please use my affiliate link and we will both get $5 to start.
6. Keep your emergency fund in an easily accessible account
There is no point to having an emergency fund that you can not access. I have heard people with little to no savings and a pile of debt tell me they are ok in case of an emergency because their home has equity. Pardon me but that is about the dumbest fucking thing I have ever heard.
If you need $5000 cash tomorrow because your car exploded, how are you going to access that cash? You can’t. You may be able to take out a loan against the equity of your house bat that ain’t cash. That is piling on more unnecessary debt.
You need to be able to go to an ATM machine and take out $500 bucks to fix your car. You might need to be able to write a check for $5,000 to buy a new used car. Whatever the emergency is, you will probably need to access the money fast. It needs to be held in an account that you can get it out of.
A high yield 6 month CD does not count. Your 401k does not count. Equity in your home does not count. Got it? If your oil tank and boiler need to be replaced in the dead of winter in the Northeastern United States, on a Sunday no less, you ain’t gonna wanna wait until your funds become available to you to get it fixed.
7. Stick with it
Saving large sums of money is a marathon. You need to stick with it in order to succeed. If you follow the steps laid out here, this will become easier. Even if you do, I can assure you there will be times when you are tempted to dip in to your emergency fund or even just stop contributing to it.
You need to be strong and resist the urge to do so.
Good luck and happy saving
Earl