What would happen right now if you had an unexpected $2,000 emergency? Something bad happens in your life and it is going to cost you $2,000 right this second. According to a study done by FINRA, only about 40% of you have the capability to come up with the money in cash. What about the rest of us? How many things in your life right now could easily cost you $2,000? You need an Emergency Fund.
If you have made it this far in life, you know there are going to be financial emergencies that will pop at the absolute worst times. It could be a job loss, a downsizing, or a “restructuring” at your company. Your son breaks his leg, your daughter backs the car into whatever, or you get a call that you are going to have to bury a loved one. We can get really creative here, but the point is simple: emergencies are (unfortunately) part of everyone’s financial plan.
Money Magazine states nearly 80% of us will have a major financial emergency in any given 10 year period.
Where to Start with The Emergency Fund?
Money experts and financial gurus all over have determined that a 3 – 6 month emergency fund should be part of everyone’s financial plan. I completely agree with them. Let’s break that down step-by-step to see exactly what this really looks like and the steps to getting there.
Step #1: Determine if you need 3 or 6 months
This question comes up all of the time and here is what I recommend. If you have a very stable job, you know you get paid every 2 weeks or you get paid on a regular schedule, I would recommend a 3 month emergency reserve. If you are 100% commission based, money comes in very infrequently, and there is volatility in your niche, then build up a 6 month emergency reserve. If you are in the middle, then you’ve guessed it, 4 – 5 month reserve.
Here are some examples of families who have set up their own emergency funds based on their careers:
Teacher: 3 Month Emergency Fund
Realtor: 6 Month Emergency Fund
Engineer: 4 Month Emergency Fund
Hair Stylist: 5 Month Emergency Fund
Small Business Owner: 6 Month Emergency Fund
Firefighter: 3 Month Emergency Fund
Sales & Marketing: 6 Month Emergency Fund
Nurse: 4 Month Emergency Fund
Office Manager: 5 Month Emergency Fund
Step #2: Don’t Save it All Up at Once
This sounds strange, but follow along and you’ll see what I mean. You are going to look at your BUDGET and determine what you would NEED if you were to experience a major financial emergency. This doesn’t mean cable, fancy restaurants, and the latest smart phone. This means, how much would I need to live a bare bones lifestyle until I got back on my feet. You are going to need food, housing, utilities, gas for your car, insurance, and the basic necessities to make it to see another day. For some of you this could range anywhere from $5,000 – $25,000 or more depending on your lifestyle you are currently living. Wow, right!? We also have other things we are supposed to be doing with money (paying off debt, investing for your future, saving for ______, etc.). Therefore, we need to save some of it right away in our STARTER EMERGENCY FUND, and then we will come back later and top it off. Here are some guidelines for your starter emergency fund:
Your Income is….
$20,0000 or less: Save up $500 for your STARTER Emergency Fund
$20,000 – $50,000: Save up $1,000 for your STARTER Emergency Fund
$50,000 or more: Save up $2,000 for your STARTER Emergency Fund
This needs to be done as quickly as possible. You need to create a game called “How fast can I get my starter emergency fund?” You need to sell stuff on eBay and craigslist, have a garage sale, pick up overtime, sell plasma (someone actually tried this), and pinch every dollar in your budget to get there as fast as you can. For some of you this is going to be a piece of cake and you may already have your starter emergency reserve. For others, this is going to be HARD, but will also be one of the most rewarding things you have done with your money in a long time.
Step #3: Park Your Money in the Right Place
You finally saved up your starter emergency fund of $500 – $2,000 and you need to know where to park it. I would suggest placing it somewhere safe and easily accessible, however, far enough away so the door-to-door salesman doesn’t get it when they stop by to sell you a vacuum (I really don’t think anyone does this anymore, but you get the point).
Stick it in a safe in your house or in a hiding place that only a few people know about. Your underwear drawer is NOT a great place – everyone looks there first. The bank is a great place for it, just make sure it is in its own account that holds emergency fund money ONLY.
You could also park it in as one of your sinking funds – this is what I do. We need this to be separated from all of our other money, but easily accessible. Nickname your account “Emergency Fund” so you know it’s there and it’s for emergencies only!
Pro Tip: Use CIT Bank to earn 1.55% on your sinking funds. Every penny adds up!
Step #4: Finish the Emergency Fund
I don’t want you to spend all of your time building this large emergency fund while you still have debt to pay off. It will become exhausting to build up a $15,000 emergency reserve when Chase Visa, your car payment, and your student loan are tackling you from behind. This is why you should begin with your starter emergency fund to get your through the rough patch when disaster enters your life. After you get your starter emergency fund, you need to pay off your debt using the DEBT SNOWBALL tool. Once you are debt free but the house, finish the emergency fund! It will go a lot faster when you’re not having to send your money to your creditors and it’s fun to watch your emergency reserve quickly grow! Yay, you now have money:) Boom!
Step #5: Sleep Better at Night
Think about this with me. You are lying in your bed before you fall asleep and you realize you don’t have debt anymore. You also have $10,000 sitting in an account earmarked for emergencies. There stress is gone. You don’t worry about what will happen tomorrow because you could just write a check and be on with your day. You start to realize this is what financial peace feels like.
A recent poll showed 64% of Americans could not cover a $1,000 emergency if one were to come up. Instead, we have relied so heavily on credit, that we even use our credit cards as our emergency fund. We have a financial hardship or devastation, and this is the time in our lives where we choose to get further into debt!? Isn’t this a terrible plan?
Emergency Fund Pitfalls
Your emergency fund needs to be for emergencies, which means it needs to be for unforseen or unplanned expenses. You know you are going on a vacation or you are needing a new couch. Not an emergency. You know when your kids smile they will eventually need braces. Not an emergency. You know your car is going to have to eventually get new tires and you know your taxes are due ever year. Not an emergency.
However, your neighbor calls to let you know water is pouring out of your house from the front door – Emergency. Your son gets stitches after he takes an elbow to the face in a basketball game – Emergency. You hit the gas when you think your car is in “R” and plow through the front of your house – Emergency. A tree falls over and lands on your car – Emergency. You get the point.
Don’t be caught in the storm. Six out of ten people are going to get hurt when a financial emergency pops up unexpectedly. This means if you are normal, you are going to get hurt! Be weird and have a plan for your life and your money. Get your emergency fund on! 🙂
Be good to yourself, your friends, your love, and BE GOOD TO YOUR MONEY!
It’s scary how many people neglect funding an e-fund (or think they don’t need one). It’s also amazing that by having an e-fund most of your “emergencies” just disappear. We’ve never had to use ours (yet) but there will never be a day we go to sleep without an e-fund.
It is tough to put money in an emergency fund when you have credit card debt- the interest rates on the credit cards is a lot higher than the likely return you would get on funds set aside in an emergency fund. I think that most people with credit card debt would be better off paying the credit cards as quickly as possible, and then putting money into an emergency fund. Is my thinking on this faulty?
Your thinking isn’t faulty, just of a different opinion. You are using the math portion of personal finance for your decision making process and I am focusing on the behavior area. Yes, you are exactly right – the interest is much higher on a credit card than on your best money market account or savings account 100% of the time. However, if math were the real problem here, people wouldn’t be in debt. No one says “I can’t wait to carry a balance on this credit card and pay 24% interest for the rest of my life.” A behavior change is what causes you to move the needle in personal finance. This is why I recommend starting your emergency fund of $500 – $2000 to get you through an unexpected rough patch and then getting out of debt. Once all debt but the mortgage is gone, now you can address your fully funded emergency fund. Thanks for the comment Dr. Penny Pincher and you’re not wrong at all. We just have different opinions and on this website I am right and on your website you are right! 🙂
We started a 30 day no spending month for August to tackle our emergency fund. Day 5 and we are feeling pretty good. I am sure by day 25 we will be getting really creative about what to fix for dinner but it will be worth it.
How do I say this without sounding like a stalker….
I am obsessed with your blog! I’ve been binge reading basically every single post since yesterday. It’s really refreshing to see you tackle subjects that a lot of financial bloggers are overlooking. Thank you so much!!!
Now to be really annoying (but I mean well I promise):
Your underwear drawer is NOT a great place – everyone looks “their” first. — Shouldn’t it be “there”?
Haha! Thanks for catching my typo. Just another bit of proof that I am still human. 🙂