Day 2 – Create An Emergency Fund


Yesterday, I showed you how to assess your financial health. Today, we’re going to talk about budgeting for the unbudgetable — uncommon emergencies that crop up from time to time that haven’t been accounted for in your budget. To do that, we’ll create an emergency fund.

What is an emergency fund?

An emergency fund is what it sounds like: a fund of money that you set aside to be used for emergencies. It’s not there to pay for your vacation or to buy the latest iPhone. An emergency fund exists to do one thing and one thing only: to transform disasters into nuisances.

A good emergency fund has three qualities:

An emergency fund needs to be accessible. Store your emergency somewhere you can reach it quickly and without penalty, like a high-yield savings account. It’s usually not a bad idea to keep some cash stored in a safe, hidden place in your home, in case you can’t access your accounts.

An emergency fund needs to be safe. Don’t lock your emergency fund up in volatile investments. Emergency funds are about security, not growth — if you’re risking it hoping for a big payoff, you’re missing the point.

An emergency fund needs to be adequate. Your emergency fund needs to contain enough money to sustain you through the types of emergencies your lifestyle is likely to encounter. You can’t prepare for everything, but a too-small emergency fund is only a small benefit if everything hits the fan.

Let’s talk about why you need an emergency fund.

Why you need an emergency fund.

We like to think of emergencies as unexpected events, but they’re really not. Rather than unexpected, most emergencies are actually just uncommon. Sometime in the next year, there’s a reasonable chance that you may find yourself needing some form of medical care — your dentist tells you that you need a crown, or you catch strep throat from a coworker, or you slip off a ladder and break your ankle. A storm drops a tree limb on your car, the dog eats something poisonous and needs veterinary care, or the computer you need for grad school suddenly gives up the ghost and dies. It could happen tomorrow, it might not happen for months or even at all this year, but it will happen eventually, because such events happen to everyone at some point.

Trying to account for every one of those might-happen events in our budget would needlessly complicate things, so we’ll create a pool of floater money — an emergency fund. When those events crop up and throw a bill for a few hundred (or thousand) dollars at us, we’ll have the ability to draw from our emergency fund to cover it.

But I have insurance for those things!

If you have insurance to cover some of these emergencies, great! Insurance is often well worth the price, and you’ll be glad you have it when you need it. But it’s impossible – or simply not cost-effective — to insure against everything. Even with insurance, there may be times where your insurance doesn’t cover a specific event, or where you need to pay for it out of pocket and get reimbursed by your insurance company later. Your emergency fund exists to take care of things in those situation.

Let’s talk about different stages of emergency funds.

Stage 1 Emergency Fund – $1000

Most relatively small-scale emergencies can be resolved (or at least substantially mitigated) with $1,000. If you have no emergency savings, this is your first goal — to find and save $1,000. That can sound like a lot of money if you have nothing saved at all, but with a little work, you can gather it easily — I’ll explain how in a few minutes.

$1,000 will replace most appliances in your home with at least a basic functional model — washer, dryer, stove, refrigerator, dishwasher, computer. Depending on your vehicle, it’s probably enough to replace most parts. It’s enough to handle a decent range of minor medical issues, including the inevitable “What do you mean this antibiotic is $200?” moment at the pharmacy.

Your Stage 1 emergency fund doesn’t necessarily have to be $1,000, but it should be a quickly reachable number with some weight to it — maybe an amount equal to one month of your income. I want to emphasize the “quickly reachable” part. If you have no emergency savings, I want you to try your hardest to acquire a Stage 1 emergency fund by the end of this month. Later in the month, I’m going to talk about how to increase your income with side gigs — if you have no emergency fund, that extra income can be put to good use funding one.

Stage 2 Emergency Fund – 3-6 months expenses

Our Stage 1 emergency fund takes care of minor emergencies, but what about bigger issues? What if you lost your job today and couldn’t find work for several weeks? What if a storm took out a quarter of the roof on your home, or you had to completely replace your car unexpectedly?

Enter the Stage 2 emergency fund. This is a much larger emergency fund, designed to sustain you through larger emergencies. We can build it up over a slower period of time. The goal is to eventually save about 3-6 months of expenses. If you and your spouse both have stable jobs, you might be able to get away with the smaller amount. If your source of income is unreliable or unstable, you’ll want to aim for a larger amount.

A good way to build your Stage 2 emergency fund is to use automatic deposits. Your bank can set this up so that every time you get a paycheck, a portion of it (the amount designated by you) gets automatically deposited into the account storing your emergency fund. Of course, if automatic deposits aren’t your style, you can build your Stage 2 emergency fund however you like. My wife and I initially supplemented ours with our tax return, and one of my friends built his by selling the timber on some property he owned.

I can’t afford to put money away for an emergency fund! What do I do?

Look, 28% of Americans have absolutely nothing saved for emergencies.Nothing, not even a dollar. If you have ANYTHING saved, you’re doing better than about 88 million people. If you can’t put away $1,000, put away what you can. If you put away $100, or even just $50, that’s $50 or $100 you won’t have to scramble to find the next time an emergency fund comes up. Over time, you can build your emergency fund up.

If your budget is too tight to afford to put any of your standard income towards your emergency fund, here are some quick things you can do that I guarantee will generate some cash by the end of the week. Do a few of them, put what you can away, and grow your fund whenever in the days ahead:

  • Look around your home and gather up any books, movies, music, videogames, or old electronics you aren’t using. Take them to a second-hand store and sell them. My wife and I have done this in the past and been able to earn as much as $80 just from selling our old stuff.
  • Check out /r/slavelabour, a Reddit subforum dedicated to quick tasks for quick cash. Frequent jobs posted include things like proofreading or transcription, beta-testing apps, small-scale graphic design or photo or video editing. If you don’t see something to apply for, post your own ad stating what you’ll do and for what price.
  • Hop on Facebook and ask if any of your friends or family need any help. Babysitting, housesitting, dogsitting, mowing lawns, cleaning out garages or other helpful tasks will consume a few hours of your weekend at most, but can put some substantial cash in your pocket (which should then go straight from your pocket into your emergency fund.)
  • Sell plasma. My wife and I have done this a few times — if you’re in good physical shape, plasma donation is a great way to earn $50 or more a week. Just make sure your research it first and donate through a clean, safe, reputable donation center.

Why credit cards aren’t an emergency fund

(but may still be useful)

Ask a handful of Americans, and you’re sure to turn up a few who will tell you that they have a credit card, but “only use it for emergencies.” If you could get them to talk a little more openly about their credit cards, I’m sure you’d find that most of them use their credit cards for quite a bit more than emergencies, but getting them to admit it is hard.

But for now, let’s take the statement at face value. Is it possible to just have a credit card and not worry with saving an emergency fund? Sure. You can totally do that, and many people do. The average credit card has an interest rate of15.38%. If you want to use a credit card instead of an emergency fund, I want you to repeat the following: “When an emergency comes up, I want to pay 15% more for it than I needed to.” Does it still sound like a good idea?

Despite that warning, I want to tell you something: my wife and I do use our credit card for emergencies. We do it because our credit cards provides a nice cash back reward, which means we’re getting some money back if we end up having to spend $500 on a new appliance or a few hundred dollars on a medical emergency. But we still have our emergency fund, stored in a savings account with a nice interest rate. When an emergency comes up, we pay for it with the card, reap the cash back reward, and IMMEDIATELY pay for it with the emergency fund, before it has a chance to accrue interest.

Tomorrow: Create A Plan For The Future

Tomorrow, 31 Days To Your Financial Future continues. We’ve talked about evaluating your current financial situation, and took precautions to deal with any emergencies that might crop up. It’s time to think ahead. What do your want your life to be like in 5 years? 10 years? 25? Tomorrow, we’re going to put together a plan, even if it’s one that might change, for the future.

Do you have an emergency fund?

Do you have anything saved for emergencies? If so, how did you fund it? Have you ever had to use it? Tell us in the comments!

Photo by Seattle Municipal Archives.

Click here to read Day 3!

Posted in 31 Days To Your Financial Future