Savings

Yes Virginia, You Do Need An Emergency Fund

What is the financial advice that people need to hear from their advisers but aren’t? Here it is: you need an emergency savings fund. And that emergency fund probably needs to be bigger than you think. I admit, it’s not as exciting as the latest IPO stock tip but way more impactful to your goal of building wealth or creating financial independence. In this post we will talk about the what, why and how of emergency funds complete with a simple 3 step plan to get started on your own emergency fund.

Now you may be thinking, I’m great at my job and my boss loves me. Or, I have an investment portfolio, a home equity line of credit, and perhaps credit cards to tide me over. Any of those resources could help but they all rely on things you can’t control falling into place.

When We Needed An Emergency Fund

Let’s think back just a few years to the Great Recession that ended in 2009. At the time the stock market was in the dumps, banks were pulling or freezing home equity lines of credit and credit card companies were reducing credit lines. You need something you can control to protect yourself from a job loss, major medical event, car crash, or any other financial setback.

After college my husband went to work for a residential builder and I went to work for a large bank. We both got very good reviews from our employers and were moving up within our respective companies. None of that mattered when the housing market crashed and took my husband’s job with it. In January 2009 over half a million Americans lost their jobs and my husband was one of them. Suddenly, we needed our cash cushion.

We were incredibly stressed by our new financial reality and the recession. On top of that, there was the psychological weight around the job loss itself. Not to mention, my husband re-entered an extremely competitive job market with millions of other Americans as the stock market cratered towards its recession-lows.

How we got through the financial stress

There were two things that we did before the recession hit that helped us survive this roller-coaster ride with our finances intact.

  1. We kept our essential expenses low enough that they could be paid on one income.
  2. We had an emergency savings account with enough cash to cover 6 months of essential expenses.

Why did these matter? We structured our spending so that our essential expenses were covered by one salary. This also meant that our emergency savings account could be smaller because we didn’t have two significant car payments, high credit card bills, etc. We had a savings account with 6 months of our essential living expenses saved in a FDIC-insured savings account.

Having this emergency savings fund in place protected our credit because it kept us from being late on our bills and loans. It protected our retirement savings because we didn’t have to sell anything while the stock market was down. Our emergency fund took some pressure off of my husband as he looked for a job. However, perhaps the most important reason to have a cash cushion is the sense of peace it can give you while your life is otherwise fairly turbulent. It definitely helped us to sleep at night.

OK, great, but if you had emergency savings, why does it matter that you didn’t rely on two incomes?

My husband worked like crazy to get a new job that winter. He set aside his ego and took a 50% pay-cut so he could go back to work. If we had been been relying on both our incomes to fund our essential expenses that would have pushed us into another orbit of crisis. Instead, when he returned to work, we were able to save money for the future and spend money on some fun things as well.

Now, many people do live in single earner households and we were able to do that as well. BUT, the reason we were able to do that is because we kept our basic expenses low. When I say "basic expenses" I'm referring to housing, utilities, bills, utilities, transportation and food. If you live in a double income household, you may be able to get away with having a slightly smaller emergency savings account. Perhaps an emergency savings fund of 3-6 months will suffice. If you live in a single income household or have a volatile earnings stream (perhaps you are an entrepreneur or in sales) you will want a solid 6 months of expenses saved.

Alright, so I need to build up my savings. What do I do now?

  • Take action. Open an FDIC-insured high yield savings account and immediately fund it with $100.
  • Look at your essential spending (loan payments, bills, daycare, something for food & gas) and multiply that number by AT LEAST 3 but preferably 6. This is your target savings level.
  • Set up automatic transfers either directly from your paycheck or from your checking account. Push yourself. Save a little more than you think you can each month.
  • Congratulate yourself on starting one of the pillars of your financial freedom!

 

An emergency savings account is part of the foundation on which you can start building towards financial freedom. In fact, after putting in enough in your 401(k) to get your employer’s match you should focus on building your emergency savings. Once you've built your emergency savings return your focus to your 401(k). That’s how important it is to have an emergency fund. So whether your goal is to quit your job and start a new business, raise a family, retire at 60, or take a year off and travel the world, you need an emergency fund to protect your long-term savings.

Email me or comment below on how you built your savings or what is holding you back.

Not sure how much you spend each month? Find out how to easily set up a monthly spending plan.

http://money.cnn.com/2009/04/03/news/economy/jobs_march/index.htm?postversion=2009040318

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