Tuesday, September 26, 2017
Starting an Emergency Fund – 5 Easy Steps
I have preached many times that having an emergency fund is essential to any solid financial plan. Most of us know that having savings is important. To not be broke is a common desire amongst most people. One thing I have preached to many of my viewers is that you should live like you are broke, even if you aren’t. That is where the emergency fund comes into play. I have an emergency fund of 1 year’s expenses, yet I aim to live like I am broke. Those funds do not exist to me unless under special circumstances. That is the essence of the emergency fund; money that is NOT to be used unless absolutely necessary. In yesterday’s post, I spoke about the urgency of the situation. Many people don’t have any savings at all and would be financially devastated should they stop earning money for an extended period. The problem for them is that they think of an emergency fund as an unobtainable goal, a number too big to achieve. In this post, I will debunk that thought and show you a 5 step process to building your own emergency fund. I think an emergency fund is crucial to everyone, so pay attention to these tips.
1) Determine what you need, or more accurately, what you can do
Experts have said that you need 3 to 6 months living expenses saved up in case of emergencies. I think a minimum of 6 months should be saved for this purpose. That amount can seem daunting to people who have little or nothing saved. Living expenses include the basic necessities that one needs to survive such as shelter, food, utilities, transportation among other items. That number can be expensive especially if you have a family. For me, that number is $2300 monthly. So that means for 6 months living expenses I need $13,800 saved up. Here is an example to illustrate my point:
Monthly Expenses 3 Months 6 Months
$1000 $3000 $6000
$1500 $4500 $9000
$2000 $6000 $12,000
$3000 $9000 $18,000
$5000 $15,000 $30,000
You can see how that number can get quite large as your monthly expenses grow and grow. It is reasonable to need $5000 monthly if you have a large family with large family needs. Tackling this situation can seem impossible so it becomes important to set small emergency fund goals at first. Start off with $500 and then move on to $1000. Saving that first part may take you a while especially if your budget is tight. Even if you can only put away $25 a pay, it will only take you 4.5 months to accomplish the $500 goal. While you are working on that it becomes important to focus on our next step.
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2) Reduce Expenses if Needed
I think everyone can find something that they waste money on to get rid of. If you cannot find an extra dollar at the end of every paycheque to put towards an emergency fund, then you have to either a) Make more money OR b) cut spending drastically. More than likely the answer to that problem is to do both. Go over your VISA bill or bank statements and highlight any expenses that aren’t crucial to your survival. This can include coffee, alcohol, gambling, dining out, ordering in, parties, events, gifts, etc. By going over a detailed list of your fixed monthly expenses you can determine if you should have extra money every month. If you don’t, then I’m sure you can find out why. If you can’t find the extra money then you must make more money and that might mean picking up part-time work or looking for better work. The emergency fund should take precedence over all else in your life until it’s created.
25 Things People Waste Money on – LifeHack
3) Focus on Maintaining Positive Cash Flow
The term positive cash flow is just a more complicated way of saying don’t spend more than you make every month. You have to understand that saving money while accumulating debt at the same time accomplishes nothing. For some people, this has become commonplace. What needs to be done is have a positive balance at the end of every month so that the emergency fund savings is not in vain. This means some people will have to not use the credit cards or the lines of credit. It can become far too easy to charge something to your credit card because you have already put away money into savings. Every single month should have a positive number beside it and that includes when a large expense comes up. That is only possible when you have emergency savings so I’m sure you are starting to see the importance of them. This section often ties into the second tip and also becomes a lifelong journey. We criticize businesses and governments that run deficits; we should feel the same about ourselves.
4) Any Savings you Create is Dead to You
There is absolutely no point in having emergency savings if you cannot stop yourself from using them every time your favorite store has a sale. In section 1 I mentioned how you can start small with your goal. It is at that time you must be extra careful not to spend these savings. When savings levels are small it becomes too easy to spend the money because a few hundred dollars doesn’t seem like much. Whether it is your baby emergency fund or a fully funded emergency fund you must have the mentality to not spend this money. Tying into the last section, you must not accumulate debt and then use the emergency fund to pay off these debts. The money is gone unless there is an actual emergency and then you work to build up the emergency fund again. Savings aren’t savings if you use them not for their intended purpose.
Frugality Now, Wealth Later – Budget Boss
5) Don’t Stop Once you hit Your Goal
Once you have created the emergency fund and it is fully funded, don’t stop there. I think the growth of an emergency fund is a lifelong journey. At first, it is to provide you funds in case costly events happen. Then it becomes a buffer to cover you from illness/job loss/sickness/etc. Soon after, it becomes a fund that allows you to feel comfortable in all your endeavors. This includes business opportunities, schooling, investments, and many others. The only difference between a small emergency fund and a large emergency fund is what you can do with it. That is why I think it should be a lifelong goal of everyone to save money that has no intended purpose other than to provide you with the ability to take advantage of opportunities. If you don’t stop when you have hit your goal you might find the opportunity that you encounter is early retirement and who wouldn’t want that.
Having money stashed away for a rainy day becomes a lifelong habit. As you get older the only thing that changes is that the emergencies become more and more expensive. That is why I think the savings for this fund should continue even after the goal is hit. Having this money saved will provide you with peace of mind, discipline, and a satisfaction that life won’t stop you. In my own pyramid of financial needs, the emergency fund is the base. All other financial goals stem from there and creating that base has made all else possible.
“After two decades of personal finance reporting, I’ve heard every excuse in the book for not saving money. That said, none of them really hold up – at least over the long term.” – Jean Chatzky
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