Nothing brings me greater security than having money in the bank. I know that if something comes up, we can probably cover it. That sense of security cannot be bought (okay, maybe with life insurance ? ). Even life insurance cannot provide day to day security for the medium sized things that pop-up. Having a financial cushion is an absolute must for every household. In this post (the fifth of the personal budget series), I will guide you to save for an emergency fund so that you can also have a sense of security.
Don’t forget to make your budget first! We need to know how much money you have to save after all of your expenses each month. And then read the rest of the series too:)
Why emergency funds?
With the amount of debt in this country, I would have to surmise that emergencies are covered with more debt. A true emergency fund is not a high credit limit, but a large amount of money in the bank. I am sure you have had an emergency in the past year that involved needing money, right? Let’s discuss this.
Your tire is found flat with a screw in it and it costs $200 to replace it.
A small trip to the urgent care ends you up with a $500 medical bill.
Your water heater kicked the bucket and now you have to replace it, and quickly, for $800.
What about bigger deals like a loss of a job, a big medical bill, or a total loss of a car? What would you do then? Would you go to your credit cards?
Your large emergency fund will prevent such a guttural reaction to small to medium sized “emergencies” knowing that you have a cushion to fall back on. Read this post from Making Sense of Cents about why you need an emergency fund, just in case you are not convinced yet:)
Small emergency fund first
I truly believe that every person should have a small emergency fund fully accessible at all times. This may be as little at $200 or as much as $1000. No more than that until all of your debt is paid off. If your debt is not paid off, you need to work on that before you save any more than $1000. You will end up paying too much interest if you just paid minimum payments while you fully stocked your emergency fund.
This small emergency fund will help you while you are paying off debt. You will have a bit of security even if something comes up like a popped car tire and you will be less likely to accrue more debt. A smaller “emergency” is also where you would use your envelope system. If you have a good envelope system in place, one where you are contributing to them monthly, then you will have more flexibility with money. Be sure to read my post about setting up your envelope system, why it is effective, and how to get started.
Grow your fund
Once you have paid off your debts besides your home mortgage, you will start growing your large emergency fund. Many professionals recommend 3-6 months of expenses in an emergency fund. I would say that this is the bare bones expenses. If you are in a tight spot, you can cut cable, clothing, eating out, and more. I wouldn’t include those in your emergency fund unless you feel strongly about your lifestyle OR you want to extend the amount to 6-12 months of emergency funds. This will provide that cushion for a large emergency like a loss of a job or an accident.
The amount of money that you were paying on your debt needs to automatically go into your bank once debts are all paid. Absolutely do not adjust your lifestyle after debt is paid off. Now is not the time to get lax, take a vacation, or increase your fun money. Buckle down for a few months to a year and save, save, save. The sense of security that you will have after you have your emergency fund saved up is going to far outweigh all those fun things.
Using the envelope system to save
I am a huge fan of the envelope system. I first heard about it from Dave Ramsey’s book, but the concept of setting amounts of money aside for specific items has been in practice for a while. In my house, we typically have a fair amount of money set aside for envelopes which makes it easier to splurge one month out of the year like with clothes or gifts. It can also be helpful for those not-so-big purchases that come infrequently. For example, my haircut will cost about $50. If I save $10-15 every month, then I will not have to pay for my cut out of our normal budget. Envelope systems can and should be used by everyone, but especially those with variable income and on a tight budget. Read more about envelope systems here and here.
An emergency fund may not seem all that sexy. No, it doesn’t earn you money, but you will have a great piece of mind with that fund sitting in your bank account. You have your debt paid off, don’t salvage it by not having an emergency fund. Take these few steps and save for an emergency fund starting today. There is truly no better time.
What does your emergency fund situation look like? Do you have a plan?