Personal Finance Step 3: Build an Emergency Fund
Whether you buy into the idea of become a societal outlier that actually saves a significant portion of their income and invests it or not, this step is a non-negotiable for all humans. You need money for when shit hits the fan. Because it will. Yesterday my friends washing machine decided to flood their house and didn’t even have the common decency to warn them first. So rude.
Life is rude. A few months after I became a first-time-home-owner the hail storm of the century came through my neighborhood and absolutely decimated my roof. Adios 7K. A routine visit to my doc this summer led to a $1200 procedure that insurance only covered a few hundred dollars of. Brent was laid off from his first job out of college just a few months after getting it. Lots of shit and lots of fans in this world.
If you don’t have an emergency fund, anytime something bad happens you have to scramble. You can’t take care of it because you don’t have any money set aside for unexpected expenses. Even if you are contributing to your 401K, which is great, you need to have an emergency fund FIRST so that you don’t have to go into debt or sell investments to cover the crap life throws at you.
Where do I keep my emergency fund? Your emergency fund is cash sitting in a bank. Not in bonds, not in stocks, not in your mattress. It needs to be money you can access immediately. I highly recommend finding a credit union that will give you a good interest rate or shopping around so that your emergency fund can come a little closer to keeping up with inflation. Here’s the thing about keeping big lumps of cash, you money becomes less valuable because things are constantly becoming more expensive, at a rate of about 3% per year, but your money sitting in cash is stagnant. So look for a place to keep your money that will give you a 2% or more interest rate. Here in Colorado, I have a checking account at Bellco Credit Union and they pay me 2.25% interest on my emergency fund every month (if I use my debit card 15 times, I always make sure to do so). This comes out to about $45/month that my bank pays me. $45/month is not a ton of money, but small differences add up over time. This helps my emergency fund keep up with inflation.
Lucky for us, in this modern computer age we can open new savings and checkings accounts online and research the best options without ever stepping foot in a scary bank. Some important things to note. If your bank is charging you fees, FOR ANYTHING, get out. There is absolutely no reason you should be paying a bank for a checking or savings account. They already make money off your money, they absolutely should not be charging you fees.
How big should my emergency fund be? In Step 1, we found out how much we spend each month. In Step 2, we learned that we can cut down those expenses drastically. You will use that monthly expenses number to figure out how much money you need to keep in your emergency fund. The standard advice is to keep 3-6 months of living expenses in cash. I am risk averse and would say everyone needs at least 10K available in cash at all times. I am really risk averse so I keep over 25K in cash to cover any emergency expenses. The idea is that if you lost your job, you could stay afloat and not take on debt until you found a new job. If you loose your job and get in a car accident and a hail storm breaks your house windows? Yeah that’s why I keep over 6 months of expenses in cash. Everyone has different risk tolerances and requirements. If you are single and have a reliable job, maybe 3 months of expenses is right for you. If you have 3 kids, a dog and a goldfish, you’re going to want a more conservative (i.e. larger) emergency fund number because you have higher expenses and more creatures depending on you.
How soon do I need my emergency fund? NOW. If you don’t have $1,000 in cash. You are not allowed to buy anything until you do. Seriously. Go on a fiscal fast and eat every bit of food in your house before going to the grocery store. Restaurants do not exist for you. Don’t even look at a clothing ad until you have 1K in cash that you will not touch. Once you have 1K, keep going. You need to take this very seriously until you have your emergency fund built up. This is because if something happens and you have to go into debt to cover it, you are digging yourself deeper into a hole and further away from you goals. You will be paying money (interest) to get money and it is a spiral. Bulk up your emergency fund so that when things happen, you can take it in stride and know that even though its crappy, you are going to be just fine because you anticipated and prepared for this moment. The next step we will talk about is getting rid of your debt. I put building your emergency fund before that because until you are able to handle expenses without taking on debt, paying off your current debt is like treating the symptoms and ignoring the disease.
Remember people, water tastes, champagne diet. Build that fund!