For most of my life I lived on the financial edge. It was only a few years ago that I finally got ahead of living paycheck-to-paycheck. Once I got an emergency fund set aside I couldn’t believe the peace of mind it gave me.
An emergency fund is money set aside for the unexpected. The unexpected will happen, that’s just life. I used to have to scramble and try to work extra hours, or sell something on Craigslist, or worse of all, pull out the credit card.
I waited to set up an emergency fund because other things were always more important. I would just buy this or that and then next month I would save. Or sometimes, with good intention, I wanted to put everything into my debt. Either way, not having an emergency fund always got the best of me when something came up I wasn’t prepared for.
Here are four steps I took to build an emergency fund and break this cycle:
- Open a separate account. Open a new account separate from checking and savings. A separate account helps you forget about it until you really need it. There are plenty of free checking accounts out there (I’ve used Ally before, Go Bank looks interesting). You should be able to link the account to your primary checking, but fund transfers will be delayed. Set up an ATM card or get checks and lock them in a safe box out of site and out of mind.
- Start with $1,000. Put everything you’ve got into setting aside just $1,000. Cut out anything you can from spending, work some overtime, sell something. This first step is key to what Dave Ramsey calls keeping “Life’s little Murphey’s” away. Once you have this cash you’ll be amazed to find the emergencies don’t seem to happen quite as often. Strange.
- Build up to one months of expenses. While focusing on getting out of debt, make a priority of building the emergency fund up to one month’s expenses. That should be enough to give you peace of mind while you put everything else towards getting out of debt.
- Build up to 3-6 months of expenses. Once you’re out of debt, build the emergency fund up to 3-6 months of expenses. We keep a little more than 3 months worth and it’s enough for us, but you may want a little more. (I feel secure in my job and we have extra cash available in our investment accounts.)
A common question is: “Wouldn’t it be better to invest this money?”
The point of the emergency fund is peace of mind. If you feel confident in the price stability and liquidity of an investment, it could also work, though I would not recommend it. Have the mindset that the amount we’re talking about is nothing compared to what you will be worth in future. This discipline now will help you get there.
Holding the emergency fund in gold is another option (gold is not an investment, it’s a store of value), but it’s price can fluctuate wildly on the short term, so I would still keep some cash so I’m not forced to liquidate at an inopportune time.
What is keeping you from setting cash aside for emergencies?