WHAT IS AN EMERGENCY FUND?
An emergency fund is a pool of cash or liquid money that is set aside when life hits you with unforeseen events like medical expenses, home/car repairs, travel expenses, etc.
There should always be a cushion of funds to cover those surprise events. It is generally recommended to have 3-6 months of living expenses, depending on your risk tolerance. An emergency fund helps you to stay out of debt when there are financial surprises or unforeseen expenses. It could act like a thin line that allows a person to go into debt or stay out of it when life throws something at you. The emergency fund acts like insurance.
To weather storms, one must be prepared. Recent studies indicate that only 41% of Americans could cover a $1000 emergency with their savings. The rest, 59%, will have to get into some form of debt to cover the expenses. (https://www.cnbc.com/2020/01/21/41-percent-of-americans-would-be-able-to-cover-1000-dollar-emergency-with-savings.html).
And nearly 30% of American adults have no emergency savings, according to Bankrate’s latest Financial Security Index. Only 18% have savings that could cover at least 6 months of their living expenses.
BENEFITS
Having an Emergency fund has other benefits besides financial stability and being prepared for a rainy day
1. HELP WITH LONG-TERM FINANCIAL GOALS
I’m all about long-term goals. Goals set a direction to work towards. Your goals could be buying a home, financial independence, starting your own business, getting out of debt, etc. An emergency fund helps you to avoid debt when life happens.
2. PEACE OF MIND:
An emergency fund would act like an insurance policy. You pay yourself the premiums instead of the insurance company to use that money when needed. This relieves stress and anxiety from sudden turn of events like getting fired, health expenses, etc. You can rely on your savings until you can find another job instead of going into debt. This gives you peace of mind during rough times like a recession.
3. HELPS TO AVOID SPENDING MONEY AND MAKING BAD FINANCIAL DECISIONS:
We don’t generally think about something that is out of our sight. So, saving money in a different account would be better than your everyday checking account. According to Psychology, we are more tempted to use/spend readily available money, like a credit or debit card, on impulsive purchases (clothing, electronics, etc.). These are not emergencies. So, it is better to stash your funds in a different account, and it should involve one or two steps (shouldn’t be too far) to retrieve the funds to use when needed.
There’s a famous quote by Warren Buffett: “If you cannot control your emotions, you cannot control your money.” It’s TRUE. When we buy something impulsively that we cannot afford, it leads to debt. Think of it this way – you only buy something you can pay with cash. Credit cards lead you to debt. Avoid spending money on things you don’t need. PERIOD. This keeps you from making bad financial decisions.
HOW MUCH MONEY TO SAVE?
Dave Ramsey’s Total Money Makeover recommends saving $1000 as a beginner Emergency/rainy day fund. This could cover small, unexpected expenses like car repair, pipes bursting in your home, etc. Once you withdraw money from the $1000, remember to add to it so that the fund remains at that $1000 mark. This is a good starting point to build that Emergency fund.
TIP: You can save your first $1000 in a Digital Federal Credit Union savings account (which doesn’t cost you to open it), and it yields 6.17% APY. This is more than what High-Yield Savings accounts offer.
LINK – https://www.dcu.org/bank/savings/primary-savings.html
You could ask yourself: “What would it take me to live for 3-6 months if I lose my job/income? How can I handle the expenses?” We never know what the future will entail. So, it is better to be safe than sorry. Planning helps you navigate through rough waters. In case of a financial crisis or recession, it could take a while to find employment. Most organizations could cut employees’ paychecks or even fire them depending on their business.
The amount to keep aside varies from person to person. It depends on your preferences, lifestyle, income level, etc. It would be better to put aside 3-6 months of expenses as an emergency fund that you could tap into when the time comes. For calculating how much money you would need, it would be better to consider your rent/mortgages, utilities, groceries, health insurance, vehicle expenses, etc. This gives a ballpark figure of how much you would need each month. Multiply this number by 3-6, which gives you the Emergency fund total.
For example, you need $3000 each month for expenses. Multiply this by 6 months, which gives you $18,000. You need to save $18,000 as your emergency fund. Everyone must make it a point to set these funds aside for unforeseen expenses.
GETTING OUT OF DEBT
Getting out of debt plays a very important role in your financial independence. You could consider 2 approaches Avalanche method or the Snowball method. These are going to be discussed in the next posts related to debt. Planning and establishing goals would help you achieve them better than just cruising along with life.
WHERE TO PUT THE MONEY
This poses a very big question. Do we need to save this money in checking/savings accounts, OR should we invest the money? I think that it should be in a High Yield Savings account or any other account that you can access quickly for withdrawing whenever needed, and it needs to be SAFE. Let’s consider the investing scenario – if you invest this money in stocks/real estate. What if the market is down, and you need the funds for some expenses? You would be at a loss to withdraw funds when they are down 20 or 30%. Investing should be done once you have the Emergency fund in place and are out of high-interest debt. This is what Billionaires like Warren Buffett suggest. Saving your Emergency Fund in a Savings account should be good. You could use apps like Acorns to invest spare change from your transactions.
BUILDING YOUR EMERGENCY FUND
It would be better to save part of your income whenever your paycheck gets deposited into your bank account. Generally, 10% towards your emergency fund or investing in yourself, which we will cover in the next blog posts. But let’s say you feel like you don’t have enough money left to save once you pay your bills. There are different ways you could make more money on the side.
In the current era of technology and innovation, there are many options that were not present in the previous decade. Below are some options you could choose from:
1. You could spend a few hours every week (if not over the weekend) driving Uber or Lyft if you own a car.
2. You could perform deliveries for Uber Eats, DoorDash, Instacart, etc.
3. You can also freelance in your field of interest. You can teach others English, Math, etc.
4. You can rent a room in your apartment on Airbnb instead of leaving it empty.
You must get creative. There are many options out there that you can use to make some extra money to build your emergency fund.
SPEND LESS & CUT EXPENSES
People spend a lot of money on groceries, and stores like Walmart and Target use people’s impulsive behavior. They structure the store layout so that you must cover a lot of ground to get to the essential grocery sections like milk, eggs, etc. They place many items you impulsively add to your shopping cart at the checkout counter. This doesn’t sound like much, but it adds up. So, sticking to your list would be a better way to spend less and cut those unnecessary expenses.
There would be a lot of discounts or offers online for products of interest. I prefer to search online for anything I want to purchase. This saves me time and money. Paying off credit cards or any high-interest debt would reduce the interest you are being charged. Instead, you can contribute that interest money to an emergency fund, save, or invest. You can also lower your bills by contacting the provider and negotiating the rates, OR you can shop for different providers and grab the best deal provided instead of sticking to the previous one. This applies to everything like TV, the internet, insurance, etc.
