How to Build an Emergency Savings Fund
So you are finally making some real money and finally have some income left over. What should you do with it? The list is surely long, but one of the first things you should look to do is create an emergency fund.
What is an Emergency Savings Fund?
Simply put, an Emergency Savings Fund (ESF) is an account that you use to put away savings for covering unexpected expenses. The goal is to maintain a certain account balance in perpetuity and only use it for necessary expenses.
Here are the rules to live by when creating and maintaining your emergency savings fund:
Rule #1: The Emergency Savings Fund Should Cover 6 months+ of Expenses.
The goal for your emergency fund should be to equate 6 mos. – 1 yr. worth of monthly expenses. This means if you average $3k for monthly expenses, you will want to have $18-36k saved away in your emergency fund.
The more you can have in this account, the better – up to a point. Once you reach a certain level of savings – 6 mos.+ – then your next step will be to start up a savings account.
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Rule #2: Use Only in Emergencies
Only use this to fund purchases that are necessary and unforeseen. Discipline is the key to this step – the emergency fund is equivalent to our ‘rainy day’ fund in that we want to save the money for when we need it, not continually tap it and drain the resources.
What might constitute an emergency?:
- An unforeseen medical bill.
- A car repair that you need done (assuming you use that car to get to and from work to make your active income).
- A tool that you use for work that needs to be replaced for you to continue making money.
Rule #3: Boost Your Fund if Needed
If you know you have events coming up that will require more liquid capital needs, look to boost your emergency fund. Calculate out what your estimated expenses will be and make sure to have enough money set aside in your emergency fund for those needs.
For instance, I knew that when I was buying a house, I would need to fund the closing costs and down payment. This money was going to be coming out of my savings account – the same place where I kept my emergency savings fund.
Therefore, it was important for me to not only have 6 months worth of money in there for emergencies, but also enough money to transfer for my closing costs and down payment. By planning ahead, I was in a much better position with regards to my emergency fund.
Rule #4: Keep It Conservative
Keep your investments conservative. It is recommended to not have your emergency fund invested in aggressive stock options as these may lose value, which would cause your emergency fund to be less than expected when needed.
The goal is to have your funds in a high-interest paying money market account that is FDIC insured. Here at MoneyByRamey.com, we have been using the services of Capital One 360 and highly recommend opening an account.
If you only take away one rule from today remember to use the emergency savings fund only as a last resort. Tap into them only if you have a necessary expense coming due which you cannot cover through current cash flow. Your future you will thank you for being prudent and building this fund.
Some examples of what these situations might be where utilizing the emergency savings fund would be a good use:
- You lose your job and need to pay the next month’s rent.
- Your car breaks down and you need to fund the repair.
- Your roof leaks and rather than let the problem grow, you tap into your emergency fund to pay for a new roof.
- You do not have steady income at the moment and need to put food on the table.
- An unforeseen medical bill comes at you. This is truly a worst-case scenario. It is advisable to have health insurance and to ‘know your risk’ – the amount to which you’ll need to pay should an unforeseen medical situation take place.
A few examples of a poor use of your emergency fund:
- A new TV purchase that you really want.
- A down payment on a new car that is well above what you would need to get from point A-B.
- An investment (i.e. gamble) in your friend’s new business.
- A new cell phone, boat, car, laptop. A good general rule of thumb: anything that is a want should not be purchased through the emergency fund.
Keep in mind that it is up to you regarding what is and is not considered an emergency expense. However, being Financial Freedom seekers, we always want to ask ourselves the hard questions and be completely honest with ourselves.
Still not convinced?
Here are the top 11 reasons to have an emergency fund:
Reason #1: Your money will be making money in a high-interest savings account. Your money will be working for YOU on a daily basis.
Reason #2: You will be paying yourself first. It is important to put aside that money for a rainy day.
Reason #3: Future you will thank the present you. When that unexpected bill comes in the mail that you need to pay, future you will thank present you for planning ahead.
Reason #4: You will have serenity and peace around financial affairs. This peace will come from having enough money to cover those pesky ‘pop-up’ expenses that each of us deals with.
Reason #5: If you lose your job unexpectedly, you can take some time off without it being a financial disaster. Heaven forbid you lose your job, but if it does happen and you have been saving up an emergency fund, leaving or being let go becomes a much less frightening circumstance.
Reason #6: You will not be at the beckoning of your job (i.e. your job/boss will not be your taskmaster). Should you need to quit or move one, you will have ample reserves to do so. There is power in not being tied to a job.
Reason #7: You will be on the path towards Financial Freedom. When you maintain a high level of savings reserves, you have more clout and freedom to choose when and where you work. When you achieve this position, being tied down to anyone income is no longer necessary. You will have achieved the vaunted muse of Time Freedom through Financial Freedom!
Reason #8: The unexpected will not scare you. You will be in control of your destiny. When that bill comes due, you can rest assured you have the money to cover it. Upcoming debt becomes something not to fear, but to see with
Reason #9: The discipline of saving will be infectious. You will begin to notice yourself being more disciplined in other areas of your life too. You will eat healthier, you will exercise more, you will see the synergies of improving one area of your life translate into other areas of your life improving as well.
Reason #10: You will see the growth on a daily and monthly basis. When you commit to something and routinely follow through, one of the best feelings in the world is to see progress. Once you begin to save, you will want to save more. You will see your earned interest increasing, you will see your bank balance growing. All of this will lead to a more confident outlook into your future.
Reason #11: Your loved ones will be better taken care of. To me, this happens to be the most important reason of all. Nothing is worse than not knowing where the next meal or paycheck will be coming from. Whether you have elderly grandparents, children, or pets, your positive saving habits will help you help those you love.
So there you have it. Building up and maintaining an emergency fund should be one of the first items on your checklist towards Financial Freedom. Get busy and start today!
Disclaimer: (1) All the information above is not a recommendation for or against any investment vehicle or money management strategy. It should not be construed as advice and each individual that invests needs to take up any decision with the utmost care and diligence. Please seek the advice of a competent business professional before making any financial decision.
(2) This website may contain affiliate links. My goal is to continue to provide you free content and to do so, I may market affiliates from time-to-time. I would appreciate you supporting the sponsors of MoneyByRamey.com as they keep me in business!