Emergency Fund: A Quick Guide to Creating A Healthy One

537704986

There are all kind of simple money decisions we can make that on the front-end don’t cost a lot, but on the back-end can have a huge, huge benefit.

One of them is setting-up an emergency fund.

 

No matter how well you plan or how positively you think, there are always things out of your control that can go wrong.
— David Bach

 

I’m going to walk you through how I started my emergency fund, and protected my finances from the unexpected.

Okay, let’s get started!

Up first is understanding why this is even important.

 

STEP 1. Why an emergency fund matters

Because emergencies happen.

You and I can lose our jobs, our health, or our partner. And our current circumstances may change. 

So both you and I need to have a bank account set aside to cover financial surprises, a.k.a emergency fund.

Side note: I started investing without having created an emergency fund – big mistake! That’s why planning for the unexpected is currently one of my biggest saving goals. 

As my wise friend Ramit says:

One of the primary differences between Rich people and others is that Rich people plan before they need to.
— Ramit Sethi

 

STEP 2. Know your monthly expenses

Personal finance experts and enthusiasts alike generally recommend you stash away three to six months of basic living expenses in your emergency fund. 

So the first thing I did was facing my numbers to find out how much I normally spend in a month and what my basic living expenses are (housing + food + transportation).

Honestly, it was a painful exercise. 

I’m not a numbers person, and I knew that by checking my expenses (transaction by transaction) the spender part of me would feel very guilty.

But I’m so happy I did!

Now I have a clear picture of where my money goes (and I’ve detected some spending habits I can modify, too.)

I keep track of my monthly expenses in a Google Sheet. It looks something like this: 

Monthly Expenses And Category Distribution

There are tons of great apps out there, but I prefer doing it manually. I do it once a month and it takes 20 minutes. Literally!

Once you know your numbers, it’s time to decide how many months of basic living expenses you want to include in your emergency fund. 

My goal is to save a full year of expenses. But it all depends on your circumstances and your lifestyle.

Just remember –  you don’t have to fully fund an account all in one go. Save what you can, even if it’s small. Anything in the bank is better than nothing.

 

STEP 3. Select an account

The key to an emergency fund is accessibility

Most financial pros recommend that your emergency be highly liquid. The point of this fund is not to build wealth; the point is to have money where you can access it quickly if not immediately.

The easiest way to do this is by using a regular checking or savings account. I bank with ING so I created a separate Orange Savings Account named "Emergency Fund". Just that simple.

 

STEP 4. Automate your savings

You've heard the saying "out of sight, out of mind." That's the best way to store your emergency money. Make it automatic and transfer your chosen amount before you can even see it.

How? Easy peasy. 

Schedule automatic monthly payments from your checking account (or a portion of your paycheck) to your emergency fund. 

This is exactly what I do so I don’t have to remember to do it myself every month.

 

STEP 5. Don’t touch it!

The emergency fund is for a real emergency. 

You may be tempted to use it for something frivolous like a pair of designer shoes, a smart TV, or even a vacation – not exactly an emergency. 

Most of the time, you shouldn’t touch the emergency fund at al. It just sits there earning a bit of interest and waiting until you actually need it.

 

Bringing it all together

Your emergency fund is not an investment, it’s insurance with one purpose – to protect you.
— Dave Ramsey

Financial surprises are a part of life – hoping they don’t occur is not a viable strategy.

That’s why building an emergency fund is a good plan. It protects you in case of any event, big or small: home repairs, your basement flooding, you name it.

Before you know it, your life won’t be disrupted by these kinds of emergencies – and you’ll sleep a lot better at night knowing that. :)

Yay to that!