Emergency Fund - Step 2

An Emergency Fund is Step Two

Why Should I Have An Emergency Fund?

Life constantly changes. We experience ups and downs, some we see coming and others blindside us completely. Unexpected events are always part of your landscape, so setting aside money that will help you make it through those various rough patches will give you peace of mind. As you implement these strategies and tactics, it will help you get your emergency fund in place, which will impact your financial decisions in different ways. For example, if you have no emergency savings to help with unexpected expenses you may want to channel more money to that at the beginning of your 10-year financial freedom journey than you will later on when you have more of a safety net in place.

The current situation for those living in the U.S. when it comes to emergency savings is complicated, with varying data and interpretations of that data, as this Cato article explains. For certain those with lower incomes are struggling even more, according to this paper from Wisconsin-Madison University. However, what is clear is that many of us are not prepared for emergencies that require money to solve or at least mitigate.

It stands to reason that you need to get your emergency finance plan in place as quickly as you can.

How Much Emergency Fund Do I Need?

The answer to this question is going to vary and may change as your situation and finances change. But let’s just start with a bare minimum. Your first goal here is to get $1000 in your emergency fund. A basic savings account at your bank or credit union will work for now, although you should get it into a high yield savings account as soon as you are able.

Think about the types of emergencies that might come up and how much money you would need in order to weather them. Things like being out of work, illness or injury – those are the major ones. But consider smaller things too, like the need to replace a furnace or fly to another state for a funeral. How will you meet those expenses without incurring more debt?

Having 3-6 months’ worth of monthly expenses in savings should cover you for most emergencies. So knowing what your monthly living expenses are is crucial. This is where the calculations and work you did in step one, Intentional Spending, will help you plan how much you need.

Begin by saving 1% of your income each week, and work to make that a habit. After a month or two increase it to 2% and keep incrementally increasing it until you are saving 10% of your income. Not all of this will go into your emergency account, in fact, most of it will not once you have the initial amount in place.

What you want to do here is begin to create what is called personal margin. Simply put, this is the difference between what you make and what you spend. We discuss different ways to increase your personal margin on both the podcast and here on the site. What I want to stress here is that one of the first places you start to put that personal margin to use is in building these savings.

Best Accounts For Emergency Funds

Of importance is that your emergency funds be liquid, easy to reach. This does NOT mean it has to be under your mattress though. Liquid does not always mean immediately accessible. Sure, for some emergencies having actual cash on hand would be important, but for most situations, you just need to be able to access those funds without taking a large penalty or loss to the capital you’ve put into that account or investment. like you would if you had all of your emergency savings tied up in the stock market or something similar.

You need the account that holds your emergency funds to be separate from your other accounts. In fact, you need to have separate accounts for the various purposes you have for your money- investing, living expenses, emergencies.

As mentioned above, a high yield saving account should be one of your savings vehicles, for the amount of money you determine you would need to access very quickly. After that, you will want to start putting this money into accounts and investment strategies that can yield a higher return but still will not risk the initial capital much. Once you have that 3-6 months of living expenses you will not concentrate your focus here and look to increase returns on the 10% of your income that you are saving on a monthly basis.

How To Build An Emergency Fund

Building up your emergency fund is a high priority, so devoting thought and energy to it is key. In fact, for most people, this should be a much bigger priority than other financial goals. Sure, getting out of debt or investing for maximum returns is crucial to your long term goals, but you need a safety net, so get that in place as quickly as you can. This does not mean that you should not work on those other aspects of your financial landscape, just that this one is of paramount importance until you have it in place.

Action Steps

1. Honest assessment. How much savings do you currently have and how much do you reasonably need? What are your monthly expenses? What are the sources of income you have and what does that total?
2. Set up a separate account for emergency funds. You don’t want to keep emergency funds in your regular household operating account.

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