The second goal for our emergency fund is to have it fully-funded. A fully-funded emergency fund has eight to twelve months of monthly living expenses saved. Some of you might have heard that you only need three to six months or six to eight months. Why am saying eight to 12 months? Because I bet most of you know someone who has lost their jobs and have been unemployed more than six months. It might even be you. If your emergency fund only has three months of living expenses in it, what are you going to do for the last nine months? This is why I recommend eight to twelve months.
Will getting a fully-funded emergency fund be easy? No, but it must be done. You will feel a freedom when you have it in place. When you go looking for a new job, you won’t exude and air of desperation to your prospective new employer. You’ll be confident and powerful. This makes you more likely to get a job faster. You can definitely survive for a whole year without a job if your emergency fund is fully-funded.
Let’s take a closer look at why we need our emergency fund. We need an emergency fund because unexpected events occur. We need to be prepared for them. In the old days, people saved for a rainy day. Most of us will have a major financial event or maybe several in our lifetimes. These events could cost you several thousands of dollars. We are human none of us is immune. They are going to happen and we have to be ready.
If you don’t have an emergency fund in place, what are you going to when your child needs braces, when you need to fix your car, and for God only knows what? You need an emergency fund. Since we know that something is going to happen, is it really unexpected? No, it is not. If you are alive, then you can bet that something is going to happen.
When should you start saving? You should start saving the moment you start earning an income. Some of you might think that saving when you first start working is ridiculous. However, if you don’t make a habit of saving when you first start making money, you will find it very hard to start saving later on. I am not saying that you won’t ever save if you don’t start young, what I am saying is that you will find that other things will become a priority to you before saving for yourself. If you are not at your first job ever, think about how much money you currently have in savings. Chances are you don’t have the full eight to 12 months in that emergency fund. Do you see my point? Start saving now.
What percentage should you save? First, get your $1,000. After you get that $1,000 into your emergency fund, you should start saving for your retirement as well. If your employer has a 401(K) and they match your contributions, you need to save up to the match. If your employer offers a 401(K) Roth IRA, save your money there.
Then, slowing increase it to 5%. I know that when you are in debt saving 5% seems undoable even daunting. However, you need to start building that emergency fund. Remember that our first goal is to save $1,000 in your emergency fund.
You might say, “I can’t save $1,000 that’s a lot of money. It’ll take me years to save that amount” Let’s break it down by yearly paycheck. If you get paid every two weeks, 26 paychecks, that’s $38.46 a paycheck. If you get paid monthly, that’s $83.33. Don’t tell me you can’t afford to save. You can. If you are able to sell some stuff or get some overtime, you’ll do it a lot faster. It does not have to take you a year to save. When you file your income taxes and if you are getting a refund, don’t spend all of that money on stuff. Use it to fund your emergency fund.
After you have that first thousand in there, try to save the 5%. Although, 5% is the goal save whatever percentage you can of your gross income. Eventually, you’ll get there. Then, keep increasing it until you are able to save 10% then 15%. This most likely won’t happen for a few years, so don’t worry about it. The 15% is when you are debt-free and you are able to invest.
Where should you save? When you start your emergency fund, you need for your money to be liquid. Liquidity is a financial term. It means that you should be able to have access to your money at any time; you can withdraw it without incurring penalties and without having to wait a certain amount of time to withdraw your funds.
You should save your money in a bank, credit union, or at a discount broker. You should place it in a money market account or in a savings account. When you place your money in these type of financial instruments in these type of financial institutions, you do not incur a penalty for early withdrawal, your money is easily available, and you earn interest, albeit a small amount. A money market account has certain limitations associated with them, as do savings accounts. By law (Federal Regulation D), you can only make six withdrawals per month from your savings account. Some banks only allow three per month.
Banks require a minimum amount of money in the account in order to waive their fees. Also, if you make more than four withdrawals in a month from your savings account, the bank, by law, will switch your savings account into a checking account. Some of you might be tempted to put your money in a Certificate of Deposit, a CD. If you place your money in a CD, you do not have it readily available for use in an emergency without incurring a penalty. Your money is not liquid with a CD.
If you keep it at a discount broker, you should put your money in money market account. You can withdraw your money at any time, you can write checks a, provided you have the funds to cover the checks. Also, you don’t have to keep it in there for a specific time period before you can withdraw the money. The other instrument you can use with a discount broker is a ROTH IRA, provided you qualify. A ROTH can also be used to fund your retirement account, so your emergency fund is essentially serving a dual purpose. Be careful with this type because you cannot withdraw any of the earnings unless you are 59 1/2 or meet certain exceptions. However, you are able to withdraw your contributions – the money you put in.
Some of you might think that keeping the money at home is a great idea. It is liquid. The problem is that it is too liquid. When you have the money sitting at home, you might be tempted to use it for dinner when you are too tired to cook or to pay for a night out. These are not emergencies. Keep your emergency fund for emergencies only.
As Dave Ramsey says, “An emergency fund is Murphy repellant.” This goes back to Murphy’s Law, “Anything that can go wrong, will go wrong”. With an emergency fund, you can repel Murphy’s law because you are able to handle the emergency. Your O-line is ready to protect you from the rush.
When your emergency fund is in place, if your car breaks down, you fix it. It is no longer an emergency. What once were emergencies are now expenses that you can take care of without getting in debt.
How should you start to save? How do you discipline yourself to save each month? You might be saying, “I’ll forget to write the check or transfer the money over to my mutual fund each month.” The best way to do it is to take a clue from the IRS. Yes, the IRS. Each time you get paid they take their share of taxes before you get your money. They do it automatically, that’s what you have to do. Make it automatic. You should start to save by withdrawing directly from your paycheck. When you make your savings automatic, you don’t think about it. Schedule it so that it comes out of your paycheck each time you get paid. The money goes out of your main checking account and into your money market account without you having to do anything or to remember to do anything. Amazing, right? It’s only amazing if you decide to do it. Do it now. Don’t wait.