In this post, I will share my experiences to highlight how important an emergency fund is and how to build one, but first, our disclosure:
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Life Loves To Kick You When You’re Down
Life has a twisted sense of humor. It is unpredictable and can come with unexpected and often costly surprises. The only way you can have the last laugh is to prepare. A great way to prepare is with an emergency fund. Without one, when the unexpected happens, and it will, you can be left debt-ridden.
You could be in your dream job one second and laid off the next. One moment, you are driving down the road with the windows down, taking in the fresh air, and the next moment, your car’s engine dies. And when you think it can’t get any worse, your furnace goes out. It happens to all of us.
Over a short few months, my car’s fuel pump failed, my water heater began leaking, and a bad storm damaged my chimney and door. Another time, I discovered my sewer line was full of tree roots. Then, while I was worrying about the hefty sewer line repair costs, my oven suddenly stopped working in the middle of baking a pizza. My personal favorite involves my fence and a tree.
One of my first acts as a new homeowner was to replace a dilapidated fence. Within months of replacing the fence, a thunderstorm rolled through, causing a big microburst of air. To my dismay, the top of a large tree collapsed onto my recently installed fence, causing significant damage. I think life is still laughing about that one to this day.
Rather than being the exception, these types of events are the norm. They happen all the time and more often than we would like to believe. So, you must prepare yourself for the unexpected with an emergency fund (and good insurance!!!!).
You Need An Emergency Fund
I am sure you are sick of hearing it, but it bears repeating: “You need an emergency fund.” It is the fine line between financial stability and soul-crushing debt. It is cold, hard cash sitting in a high-interest savings account waiting to jump into action. Think of it as your local fire department.
Like your local fire department, your emergency fund is usually sitting around waiting, milling about, earning a little bit of interest. However, when a fire strikes, it springs into action, dousing the flames fast and limiting the fire from spreading to the rest of your finances.
An emergency fund is a safety net that helps you stay standing after taking a powerful financial punch. It allows you to absorb the monetary impact of unforeseen events without relying on debt. Cash, not debt, paid for my house and car repairs, which we touched on earlier in this post. You can say my emergency fund was a financial lifesaver.
If you do not have an emergency fund, it is time to establish one. It is vital to address the issue with the urgency it deserves. As Caleb Hammer from the YouTube channel Financial Audit says, “Not having an emergency fund is an emergency.” So, now is the time to establish one, and here’s how to do it.
How To Establish An Emergency Fund
Creating an emergency fund requires only four simple steps. Although the steps themselves are easy, it can be difficult to sacrifice in the present for long-term success. That is why perseverance and determination are the secret ingredients in this endeavor. Keep this in mind as you read through the steps below.
Step #1: Determine The Size Of Your Emergency Fund
The first step in establishing an emergency fund is to determine how much money you need to save. It is important to have a clear understanding of your monthly expenses and the amount of money you would need to cover them if you were to face a sudden financial crisis, such as losing your job.
Most financial experts suggest saving up at least three to six months of living expenses in an emergency fund. The key point is three to six months of living expenses, not three to six months of your salary.
Living expenses are the essential spending necessary to survive. They include rent or mortgage, groceries, insurance, debt payments, and utilities. They do not include Doordash or Netflix subscriptions or going to the bar with friends.
A 28-Year-Old And An Emergency Fund
Suppose we have a friend named Emma. She is a single 28-year-old living in Dallas, TX. Emma is a marketing specialist who makes $75,000 annually ($50,000 after tax). She lives in a one-bedroom apartment and recently purchased a new car. Her monthly expenses are in the table below.
| Monthly Living Expense | Cost |
|---|---|
| Rent | $1,400 |
| Utilities (Gas, Electric) | $200 |
| Telecom (Phone, Cable and Internet) | $200 |
| Insurance Payments (Car, Renters, etc.) | $300 |
| Transportation Costs (Car Payments, Gas, Public Trans, Parking) | $600 |
| Debt Payments (Credit Cards, Student Loans, etc.) | $400 |
| Groceries | $500 |
| Total Monthly Expenses | $3,600 |
As you can see, Emma’s monthly expenses total $3,600. With that number in hand, she can now calculate how much she needs for a 3-month and 6-month emergency fund.
A 3-month emergency fund for Emma would equal $10,800 (3 X $3,600 = $10,800), and a 6-month emergency fund would be $21,600 (6 X $3,600 = $21,600). These numbers may seem daunting, but we will put a plan in place in the next step to help her get there.
The important takeaway from step one is you need a destination. It is hard to get somewhere if you do not know where you are going. Like a long road trip, It will take time, but any buffer you can build between you and an emergency is a step in the right direction, be it $500 or a fully funded emergency fund.
Step #2: Create a Plan and Set Goals
Emma, our 28-year-old living in Dallas, TX, has just discovered that her monthly expenses amount to $3,600 and is eager to start a 3-month emergency fund. The problem is she has no savings to speak of. While socializing with her friends and going on amazing vacations is a lot of fun, it has left Emma without any savings.
Where does Emma begin? She starts by creating a plan and setting goals. It may not sound exciting, but setting achievable targets is the first step towards progress and success.
One goal might be to save $1,000 within three months and $3,000 by the end of the year. Another goal might be to save a 3-month emergency fund within two years. If these goals seem too ambitious, Emma can aim for a more modest target of $500 within three months and $2,000 by the end of the year. Let’s see what our friend Emma does.
The Plan
After crunching her numbers, Emma decides to save a one-month emergency fund by the end of the year. To reach this goal, she must save $300/month for the next year ($300 X 12 months = $3,600). Emma’s next goal is to save a fully funded 3-month emergency fund by the end of the following year.
The good news is that she is knocking it out of the park at work and has been rewarded with a 5% raise. Emma does not waste this opportunity and puts that raise toward her emergency fund. In doing so, she increases her monthly contributions from $300 to $520 and is well on her way to having a 3-month emergency fund within two years.
Make no mistake: Establishing an emergency fund will be difficult, and it can be easy to get off track. It will require sacrifices in the short run. Instead of taking a trip to Paris, you may need to do a staycation. When out with friends, you might have to limit yourself to one drink and order from the appetizers menu rather than the main courses.
In times of temptation and difficulties, it’s important to remember your savings plan and goals. They can serve as your guiding light, helping you stay focused on the path ahead. Your savings plan is like a map, while your goals are a compass that keeps you on track and moving forward. So, whenever you feel lost or discouraged, turn to your plan and goals for direction and motivation.
Step #3: Open A High-Yield Savings Account
Calculating your monthly expenses and creating a plan is a great start, but real success comes from taking action. The next step is to begin saving, and this starts with a high-yield savings account. The key is to open a separate savings account for your emergency fund, as you want to avoid commingling your emergency fund with other savings.
Remember, the purpose of an emergency fund is to provide immediate access to cash when you need it the most. To make sure you have the funds you need, it’s crucial to keep your emergency funds separate and liquid. So, avoid the temptation to invest your emergency fund in the market or lock it up in a long-term CD, and never use it to book a vacation or to buy the latest gadget.
When opening an account, focus on high-yielding savings accounts with low fees and minimums. Online banks tend to offer the best high-yield savings accounts. They have the most competitive rates with fewer fees and hidden charges. Forget about the big megabanks, as they exist to nickel and dime you to death with fees while offering little to no interest.
One of the best things about online banks is that they offer great rates and make it super easy to open an account online. Opening a high-yield savings account through an online bank only takes a few minutes and can be done from the comfort of your couch. How awesome is that?!
A Few Words Of Caution
Read The Fine Print
Make sure to read the fine print and avoid choosing a bank based on interest rate alone. Banks often offer high introductory rates limited in size and scope to get you to open an account. These rates may only be applicable for a few months and then decrease later. Other banks may offer high rates on the initial few thousand dollars deposited but lower rates for any amount exceeding the limit. So, be sure to read the terms and conditions carefully before deciding.
Make Sure The Bank Is FDIC-insured
When choosing a bank, it must be FDIC-insured (or NCUA-insured if it is a credit union). If the one you are considering is not a registered FDIC-insured bank, move on to another bank, that is. If you bank with an institution that is not FDIC-insured, you can lose your entire emergency fund. That is a risk not worth taking.
Step #4: Automate Your Savings
We have reached the final step of the process. The most difficult steps are behind us. All that is left is to arrange automatic transfers from your checking account to your new high-yield savings account. This step can be completed in just a few minutes.
To connect your checking and high-yield savings accounts, you will need to provide the name of your bank and the account information. Once you’ve done that, specify the amount you want to transfer and the times you want it transferred each month. That’s all there is to it! Congratulations, you’ve successfully set up your emergency fund.
From that point forward, the funds will automatically transfer from your checking account to your high-yield savings account. The best part is that you will account for them like any other expense, except they are growing your emergency fund.
Conclusion: You Need An Emergency Fund
As Alanis Morissette sang in her hit song Ironic, “Well, life has a funny way of sneaking up on you.” Regardless of your music preference, the lyrics contain undeniable wisdom. For instance, while writing this post on emergency funds, my car door broke. That’s life, and it does have a funny way of sneaking up on you.
It’s impossible to predict when an emergency will occur. That’s why having an emergency fund and insurance is important to protect yourself when it happens. Your emergency fund will help you pay unexpected expenses or insurance deductibles after an accident.
Financial experts recommend having at least three to six months’ worth of living expenses saved up separately in your emergency fund. That way, you won’t have to sell your soul to credit card companies or loan sharks when an unexpected expense comes knocking. So, start saving today. Your future self will thank you.
