Building an Emergency Fund is part of a financial planning series called How to Make a Budget – Easy Steps for Beginners.
Yes, you really do need an emergency fund. Sure, there are exceptional people out there who never get sick, never have a car repair, and never lose their jobs. But I’m not one of those people.
I doubt my streak of bad luck is unusual, and I bet you’ve had some tough times during this recession too. So unless you’ve got a horseshoe permanently lodged up your a$$ (and you don’t, ’cause no one designs pants to accommodate equine footwear) then you’d better build yourself a financial safety net and start an emergency fund. Here’s how to do it on any budget.
Step One: Know what you need.
I have a sizable emergency fund. I have zero debt, no kids, a frugal husband, and a dog. So why do I keep six months worth of expenses in a safe place? It’s simple. I’m a freelance writer with highly variable income — some months I write a bunch and earn the bucks while other months I write a little less. Knowing my income on a month-to-month basis is impossible and I sleep better at night knowing I’ve got the moolah socked away in my emergency fund to make it through the less busy months. I’m also very clumsy (knee surgery, car accident, random acts of falling on my face) and highly retentive — so it’s my style to save big.
Your situation may be similar, or very different — and that’s OK. The amount of money you keep in your safety stash must be an amount that makes sense for you. Do you have debt? Kids? A mortgage? An illness? Are you single or married or supporting an Ex? Do you live in a single or dual-income household? Are you worried about losing your job? Do you have variable income? And are you clumsy?
Knowing the answers to these questions is a start, but the point here is to get a grasp of your expenses and know how much money you need on a monthly and yearly basis. Download the free budget spreadsheet to figure out your finances and better understand your household costs. Once you know your financial needs, it’s far easier to set your financial goals and aim for a modest emergency fund.
How much is enough? What the gurus say!
In The Wealthy Barber, David Chilton writes, “I’m not against emergency funds, but I do feel that $2,000 to $3,000 is much more realistic than $10,000. If you’re afraid that an expensive emergency looms in you future, establish a $10,000 credit line at your bank.”
Gail Vaz-Oxlade, author of Debt-Free Forever and host of Til Debt Do Us Part, says saving up six months’ worth of essential expenses in an emergency fund is a key component of any sound financial plan (source). And she is no fan of people taking “The Easy Way Out” by tapping a line of credit for emergencies.
“Bah! How is going into debt on a line of credit during an emergency a sensible solution? It’s not. It’s the excuse people use for not saving! Plain and simple, it’s the lazy man’s solution. And it’s expensive, soul stealing and bad planning (or would that be ‘no planning?’).”
There is no ‘one size fits all’ solution to building an emergency fund. Personally, I’m a huge fan of sleeping at night and keeping a sizable safety stash on hand for a bad day. Being prepared for the bad stuff makes me feel pretty darn good.
Step Two: Open a dedicated savings account.
I know you want to be a sneaky sneaker by keeping your emergency fund in your checking account. That’s not going to work, people. It’s just too easy to spend that cash when it’s not isolated, cloistered, and hidden away from sulfurous spend-thrift ways. To do this right, you really must open a dedicated account earmarked for emergency savings.
But where do you park these savings? Most checking accounts pay peanuts on on balances and interest rates are still near record lows. One of your best safety net bets is to find a high-interest savings account that’s easy enough to access, but out of reach enough to leave be. To find one with a fair interest rate, check out CANNEX, an independent company that compares interest rates and other financial data, and pick Canada or the United States to locate an account close to home.
If you find a financial institution offering a better interest rate than your current account, use the Switch Bank Accounts Checklist to help move your money to a more competitive place.
Step Three: Find strategies to save.
I’m not leaving you alone, sitting at the computer, with an empty account boasting a decent interest rate. Ah shucks, that would suck. I can just see the emails flying in now: Gee, Thanks Kerry!, Now what?, Is that all there is? To keep my inbox a happy place, here are five common sense strategies to help fund your new emergency savings. No, they don’t suck, and yes, they do work.
- Start simple, start small. Rome wasn’t built in one day, and your emergency fund won’t be either. So take a breather and start small by squirreling away $10, $25, or $50 each paycheck. It doesn’t sound like a lot, but this cash will add up.
- Schedule your savings. One financial guru calls it an automatic deduction, I just call it scheduling in some common sense. Many bank accounts let you transfer money at regular intervals on a schedule. If you automate the process you won’t hesitate to pull the savings trigger. Pick a day each month, automate the money move, and watch your emergency savings grow.
- It’s a bill, so pay it. You pay your bills, right? Treating your fledgling emergency fund as a bill could help you to boost savings faster. You wouldn’t want to skip paying rent, phone, or internet, so don’t skimp on paying your savings fund. Changing your mindset from should do to must do is how to make it work.
- Hit your pay before it hits your hands. Some people just can’t resist the call of cashing in a crisp new paycheck. If you’re one of these people (be honest), contact your human resources department and ask about setting up a payroll deduction directly into your savings account. If you can’t touch the money, it won’t run away from you.
- Slash, cut, and save. This is where I get mean and tell you there’s money leaking out of your life — you just need to know where to find it. Downgrade your TV package, cancel that gym membership, and try any of these 50 Ways to Save $1,000 a Year to make that emergency fund a reality. You have the money, you just have to want to save it.
Got another strategy that works? Go ahead and share your thoughts in the blog comments. There are a lot of ways to trick your mind into saving — let’s hear yours!
Step Four: Ne pas toucher.
That’s French for: Do not touch. If you’re an English speaker, then you’re not allowed to tap your emergency fund either — unless it’s a REAL emergency. And a shoe sale is not a Squawkfox-sanctioned four-alarm emergency (even though I do love shoes).
An emergency is an unforeseen circumstance that leaves you up the creek without a paddle. Since you have that life preserver (your emergency fund) you won’t tap your credit cards and drown in debt, you won’t miss a mortgage payment, and you’ll have some wiggle room to rejig your budget until the emergency passes. And when you’re back on your feet, it’s time to start saving again to replenish your emergency fund.
Are emergency savings idle funds? I don’t view my six months worth of savings sitting in a high-interest savings account as a waste or as a poor investment. Since I’ve needed that cash on several occasions over the last few years, I think funding my safety is the best investment I can make. Sleeping well at night is nice too.
Get the series, How to Make a Budget – Easy Steps for Beginners, for more free tools, tips, and downloads.
Love love love,