Step 2 to Wealth: The Emergency Fund


tree-on-carWhere would you be if you lost your job today? Most people would say that they wouldn’t be able to make it. That’s what an emergency fund is for.

Really this step should be bundled in with the “budget” step, because there isn’t really much to “do” (it’s all about saving). It’s so crucial though that I had to write about it on its own. Without an emergency fund, the next steps (paying off debt and investing) could both be rendered useless if the unexpected happens.

What Is It

  • Easily available cash that can be used for emergencies.
    • A savings account is OK.
    • Stocks are not OK.
    • Credit cards are NOT an emergency fund.

When

You should start saving towards the emergency fund the very first time you setup a budget. There should be a category for it.

How Much (Monthly)

The monthly amount put towards the emergency fund should be set at some amount that will be able to grow even in the case that some emergency does actually happen. The faster you can build up the fund, the faster you can move on to the next step.

How Much (Goal)

When do you get to stop saving for the emergency fund and move on to the next step of becoming wealthy? The typical amount is 3 to 6 months of monthly expenses, which can seem daunting at first.

Minimizing the Emergency Fund

Save 3 months of expenses and then move on to the next step, while continuing to save towards the emergency fund at a lower rate. This will keep you moving forward. Make sure to adjust as needed if you find the fund isn’t continuing to grow towards covering 6 months!

When Do I Not Need an Emergency Fund

floodYou should always have an emergency fund, even if you think you can’t be fired and even if you live in a country that has almost-free health care.

BUT, you may not need as much of an emergency fund if your budget categories already account for the emergencies. For example if you have a “medical” category that will build up over time, perhaps it’s meant to cover medical emergencies. Or if you have a “vehicle maintenance” category that builds up over time, that can cover a broken down car once it builds up a certain amount.

Be careful! Writing this section reminds me of some neighbors that I used to have. I’m a fairly nosy person, so I would like to look over and see what they were doing. What I noticed about them that was different than usual were the many empty boxes outside by the trash every week. It seemed like every week they were buying a new fancy thing. Usually it was smallish, like a blender, or a bread maker, but there were boxes really, really often. It made me think, “Where are they putting all of that junk?” and “Why are they buying all of that junk?” Then one day with little notice I saw a moving truck out front. I hadn’t even noticed a “for sale” sign on their lawn and just the week before I had seen the empty box from some product, as usual. It turns out someone lost their job and they weren’t able to continue paying the mortgage, so they wanted to move on as quickly as possible, before the real trouble started. The house sold quickly. They did not have an adequate emergency fund.

Super-Charge Your Emergency Fund

So if you have $1,500 of expenses per month and decide after budgeting that you only want to save $100 per month, then to cover 3 months you’ll need to wait 45 months, or over 3 years before moving on to the next step. No one wants to wait that long of course. Here are some tips.

  • Put any windfall that you receive towards your emergency fund. Typical windfalls include
    • tax returns
    • bonuses
    • raises
    • gifts
  • Sell what you don’t need. Read this book to get inspired (link).
  • Skip that expensive vacation, or take a cheaper one. (Cut down on things in general.)

Summary

It’s important to bundle this in when making your budget. In my personal experience we had a good idea of which unexpected expenses tended to come up after about 2 years of budgeting. Generally the culprits were the vehicle and medical expenses, with a dash of taxes and broken appliances. Your experience will be different of course.

It can be done! With proper planning in fact it just falls into place. See you at step 3.

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