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The sun won’t shine forever. That’s a phrase my late Granny would say often, but I never really understood what it meant until I started my journey towards financial freedom.
I never had an emergency fund. Gasp, I know.
Well, I thought I did, but it wasn’t in cash. I relied heavily on credit cards to cover any unexpected expenses I had, which is how I wound up amassing $18,000 in credit card debt.
But, I digress.
Now that we have built an emergency fund, we have been able to replace our laundry appliances and get a new battery for the car unexpectedly all using cash.
What’s an emergency fund
First things first, to reach financial freedom, you must have a plan. The first step should be to build an emergency fund.
An emergency fund is simply assigned dollars to cover an unexpected pitfall. This is the place you turn to when you find yourself facing a large expense you weren’t expecting.
Ideally, an emergency fund will be maintained long term, but if you need to use it, you must be able to easily access these funds quickly. A savings account with liquid funds is recommended.
Building up an emergency fund, a rainy-day fund, a safety net, or whatever you want to call it is very important. Unexpected expenses are going to happen, and it’s best that you are prepared to cover them because there’s no avoiding them.
Benefits of having an emergency fund
When you build an emergency fund, you’re also granting yourself peace of mind. You have money sitting there waiting to be called into action. You’ll no longer have to scramble to come up with the money because you have cash in place, which prevents you from going further in debt and you’ll no longer rely on credit cards.
Even if your emergency fund isn’t big enough, it’ll reduce the amount you’ll have to borrow from friends or a family member or credit card. Having an emergency fund in place will save you a lot of money in the end.
When to use an emergency fund
It’s important to note that the emergency fund isn’t a slush fund. You shouldn’t dibble and dabble in it for entertainment purposes or just because you want a new outfit or to take a vacation. It’s for true emergencies only.
A true emergency is where immediate action is required that may affect your long-term wellbeing, such as:
- Large medical deductible or emergency room copay – You can also eliminate the need to use your emergency fund for medical expenses by opening a Health Savings Account or a Flexible Spending Account during the open enrollment season. This will also help reduce your taxable income.
- Emergency travel – This could be due to a family emergency or a death in the family.
- Major, unexpected car repairs – This includes a tire blowout on the way to work or a need for a new engine unexpectedly. Regular routine maintenance doesn’t count as an emergency. Create a sinking fund to cover that expense or add it to your monthly budget.
- Major appliance failure – Your refrigerator going out is an emergency. If you don’t replace it quickly, your food will spoil, causing to spend loads of additional cash to replace all your food.
- Large, unexpected home repair – Mother nature is unpredictable. If a storm comes through your area and causes a tree to fall on your home, you’ll need to cover the deductible before your insurance kicks in.
How much to save to build an emergency fund?
When it comes to building an emergency fund, the question most people ask first is “How much should I save?”
Popular personal finance guru Dave Ramsey has laid out 7 Baby Steps and in step 1, he encourages you to save $1,000 to build an emergency fund. Then, you’ll pay off all your consumer debt before you build an emergency fund of 3-6 months of expenses.
I agree and disagree with this approach.
If you’re in a similar situation as I was in, relying on credit cards to cover unexpected expenses, starting out by saving $1,000 to build an emergency fund is a great place to begin.
For one, you’re creating a new habit of saving rather than spending your entire paycheck. And two, you’ll no longer rely on credit cards to help you get by.
But what happens if something comes up that’s more than $1,000? Do you use your credit card to cover the difference? Or what if you or your spouse lose your job? Will $1,000 cover your monthly expenses?
Rather than pretend that there is a magical answer to how much you should save, you should start by evaluating your current financial situation. Then, determine what number is best for you based on your risk tolerance. There isn’t a one-size-fits-all approach when it comes to personal finance. It’s personal.
Here are you few factors that can help you decide:
Your sources of income
If you have multiple sources of income or you are a two-income family, having a smaller emergency fund while pursuing financial freedom may be okay. The chances of you losing more than one income source at the same time are probably very slim. The theory here is that you’ll be able to cash flow larger unexpected expenses by budgeting effectively and keeping your monthly expenses lower than the lesser of the two incomes.
Your risk of job loss
While no job is 100% guaranteed, some jobs are riskier than others. If you work in an industry that’s risky, you may want to consider saving enough to cover a few months of your expenses. Save enough so that you’ll have enough cash to get by while you’re searching for a new job. If your career is stable or if your job is high in demand, you may be able to get by with a smaller emergency fund.
Your employer’s retirement plan
If your employer offers a retirement plan AND they match your 401K contributions, you should be taking advantage of this as soon as possible. Directing 3-5% of your yearly salary into a 401K account won’t deter you from paying off debt that much faster. Plus, you’ll lower your taxable income in the process.
The point I’m trying to make here is that you must assess your current financial situation and base your decision on that. Not just go by what a popular personal finance guru says.
If you need assistance assessing your current financial situation, check out my 6-week budget coaching program, cultivateHER, where I’ll help you do so.
How to build an emergency fund
Once you’ve determined how much you need to save, don’t get discouraged by the large number. The good news is that you don’t have to save it all at once whether your number is $1,000 or $5,000. You can build it up over time.
The most important thing is that you get started. If you’re currently drowning in debt and are ready to take the first step towards financial freedom, here are six things you can do this month to help you build an emergency fund today.
Sell items you aren’t using
Take a few moments and walk around your house. All that stuff used to be money.
In fact, I’ve made nearly $5,000 between those two just by snapping a photo and listing items around my house that was just sitting there collecting dust. The saying “Your trash is another (wo)man’s treasure is true.” You’ll be surprised at the things others are looking to buy.
Trim your expenses
Trimming expenses is the easiest way to save money. Money subscriptions are very popular right now and those costs can add up very quickly.
Reevaluate your monthly budget and determine if you can do without that beauty box or see if you can split the cost of your annual Amazon Prime membership with a friend or family member.
During your review, you may even find that you’re not using half the things you are paying for but decided to keep because it was only $10. But only $10 can transfer to $100 if you have 10 things you’re paying for but aren’t using.
Meal plan and prep weekly
Let’s say you stopped for a $5 coffee every morning on your drive into work. And you went to the café in your building daily for lunch with your work bestie and spent $10.
This is all hypothetical. I know you meal plan and meal prep every week already, but let’s say you didn’t.
That’s $300 that you just spent in one month.
Work Week Lunch is a great resource if you need help getting started.
When your premiums, such as auto insurance, cable TV and internet, are up for renewable, don’t forget to renegotiate your price. Most of the time, a simple phone call will get you a better rate. Just call and ask for the latest promotion or ask to bundle products for a discount.
Don’t be afraid to switch providers either to save money. We were able to save $90 on our auto insurance just by switching to Safeco and nearly $50 on our cell phone bill by switching to Tello. Your loyalty isn’t owed to anyone. Understanding this has helped add so much money back into our monthly budget.
Use a high-yield interest account
Online banks are here to stay. Don’t be afraid to use one. If the bank is FDIC insured, your money is safe up to $250,000 just as it would be at your local bank or credit union.
I love online banks because they offer higher yields of up to 2%. Most traditional accounts only offer 0.01%, which translates to pennies on the dollar.
I use Sofi Money for my emergency fund and I also have an Ally account for my business. Both provide excellent customer service and offer a high yield.
Fear shouldn’t keep you from putting your money to work for you. Do your research today and then commit to making the switch.
Use cashback apps
Did you know that you can earn money on items you planned to purchase anyway with just your cell phone? Yep, it’s true.
You won’t become a millionaire by using them, but they are a great way to add an extra source of income to make your dollars stretch. You’ll be surprised how quickly you’ll be able to earn money just by using your smartphone.
Collect spare change
At the end of each day, empty the change from your wallet and pockets into a jar. You can have your entire family join you as well. On the last day of each month, deposit that money into your savings account and watch how fast your account grows. You can even add one and five-dollar bills to speed the process up.
Having an emergency fund in place can be the difference between financial failure and financial success. Preparing for unexpected expenses in advance will help reduce your dependence on accruing more debt and help you save money in interest and other fees.
Be sure that you assess your current situation before you build an emergency fund so that you have enough set aside that feels good for you and your family.
Be sure to be smart and make wise decisions when it comes to using your emergency fund. It shouldn’t be used just because you were careless with your monthly budget.
Do you have an emergency fund? How were you able to fund it? Have you ever had to use it to cover a large, unexpected expense?