What do I Really Need to Know about Emergency Funds?
You’ve heard it so many times before. The global economy is heading for financial ruin and now is the time to guard your money like it’s your most precious possession. Tomorrow might be the day that the world’s financial system melts down and if you’re not ready, all you will be able to do is stand by and watch your financial situation implode.
The same well meaning people who give you this doomsday advice have some answers as to how protect yourself and one of those ways is to have an emergency fund. The logic goes something like this: Any debt that you have is a bet/wager/gamble on your future ability to pay back that debt. In addition, the fact that you’re alive means that you have expenses relating to food, shelter, water, clothing, etc. There is virtually no possible way to relieve yourself of having expenses but it’s exceedingly easy to find yourself in a position of no income.
You might be really good at what you do but if the global economy goes in to a recession you could lose your job. You might be a leader in your field but if you get sick or injured and lose the ability to work, your expenses will mount. You have to have an emergency fund, say the financial gurus. They’re absolutely right!
What do I need?
Here’s where the controversy starts. You’ll hear everything from enough money to pay your expenses for three months all the way to one year and more. Everybody has a different idea but here’s a better way to figure it out.
First, take a look at your financial picture. What do you pay out monthly that is a contractual obligation? Your home, your car, and your phone may be some of the contracts that you have to pay. Other contracts may have conditions that allow you to defer payments if something were to change with your financial situation. Those should ideally be factored in to your calculations but if needed, you could remove obligations later.
Once you understand the nature of your expenses, ask yourself what you could cancel in the event of an emergency. Cable TV? Gym membership? If you can quickly cancel these, they don’t have to be counted in to your emergency fund. Now, add up your monthly expenses and that is what you need to fund your life.
Also realize that you probably have a lot of expenses you can cut out. You could forgo eating at restaurants and instead, eat at home. You could clip coupons and take advantage of many other frugal ideas that could drop your living expenses considerably.
Before you decide what your monthly expenditures entail, figure out how lean you could realistically live. That number is drastically different than blindly looking at your bank account and calling that your monthly outflow.
How do I Save?
It’s easy for financial gurus to write an article and tell you to save one year’s worth of expenses for an emergency fund. How are you going to save up what is probably close to your entire year’s salary for an emergency fund. Sound unrealistic? It is…kind of.
The way you save for an emergency fund is by not calling it an emergency fund. Just save money. Make sure that every paycheck involves putting money in to a savings account or even better, an investment account. Some financial experts will tell you that you should never invest your emergency fund money because it has to be easily accessible. It does need to be accessible but appropriate investing can meet those needs.
There are bond ETFs, preferred stocks, bonds, and even low volatility common stocks that pay a healthy dividend that can help you amass your emergency fund. If you feel uncomfortable with that, put the money in a bank account and contribute as much as you can each month. Once the balance gets sizeable, find a financial adviser that you trust and have them help you put it to work in a safe way.
This isn’t an emergency fund. It’s just you saving money and if an emergency happens you have cash reserves. Over a period of 10 or 20 years you’ll have enough money in your account to live on for more than one year and if the emergency never happens, it’s going to be there for you when you retire.
Let’s Get Real
If you have no savings right now, it’s probably going to take you a long time to build up an adequate emergency fund and it would be irresponsible for somebody to tell you to stop everything and have a singular goal of putting enough money in to this fund. Do it gradually but understand that if you have no savings, cutting a luxury out of your life in order to amass a savings is not only responsible, it’s imperative.
Andy writes about comparing credit cards at CreditCardCompare.com.au. He is also the editor of their blog and can be followed on Twitter via @thecreditletter.
