Given that it's financial literacy month, now is as good a time as ever to talk about the steps you can implement to make big changes in your own finances.
Don't fight me on this—the #1 thing you need (which is also the easiest to start!) is an emergency fund — or a little cash blanket to wrap around you in times of trouble.
First, let's start off with the definition of what an emergency fund actually is.
First, What Is An Emergency Fund?
Maybe it's best if I start by listing all the things your emergency fund isn't:
- An emergency fund isn't the small cash “buffer” you have in your checking account so you don't overdraft.
- An emergency fund isn't the separate account you have with money in it for your first home, your badass next vacation, or your bi-monthly contact lens order. (….just me?)
- An emergency fund isn't the amount of credit you have on your credit card.
So that leaves us with what an emergency fund is – a separate savings account where you have enough money stashed away for true emergencies – car repair, loss of your job or income, and sickness. Money to get you through those tough times.
And trust, there are gonna be tough times. And I'd rather you have the money than hit the skids and wish you'd been saving all along.
Why You Need to Start Building an Emergency Fund First
But What If I'm in Debt? Shouldn't I Pay That Off First?
Among personal finance experts and enthusiasts, the “paying off debt” vs. “building savings” argument is as widely debated as the 2016 Presidential election. Everyone has an opinion (strong…strong… opinions) as to which is the most beneficial.
From time to time I'll get an email from a reader asking this very same question — when you're in debt, and only have a little money available for your financial goals at the end of each month- what should you do with it?
My short answer: build up your emergency fund, first.
Debt is super expensive, especially if you have a lot of it. The fact that it costs you so much money is why many recommend paying off debt as fast as you can, even to the detriment of your savings. The reason I argue for an emergency fund first, even before massive debt payoff, is because life is so unpredictable. Say you just finished paying off thousands of dollars – but then your car breaks down or you lose your job unexpectedly as soon as you made that last payment. The joy you felt at being debt free would be fleeting without an emergency fund.
If you spent all of your money paying off debt, you'd just have to use the cards again in the event of an emergency, which, after all the hard work you put in paying off your cards, house, or student loans….would be the biggest bummer.
And also akin to a dog chasing its tail all the time.
The only way to get off the hamster wheel of debt-payoff-debt is to have an e-fund.
What is the recommended amount for an emergency fund?
So, experts recommend 6-9 months of expenses (i.e. what it would cost you to just keep the lights on and the fridge full in the event you were to lose your job and have to cut back to the bare bones.) Do you know how much you spend each month in basic expenses?
If you don't, go and check your monthly budget or app (which you should have. If you don't, see this post for how to build and awesome budget and sign up for the FBL Vault in the box below to get the FREE template) and dig around to find out what your “bottom line” is.
So whatever that number is, for example, if you're all in rent, utilities, car payment, groceries at $1,000…your goal emergency fund would be $6-9,000. If you did what the experts suggest.
And that kind of money is a lot, I know.
It can be very difficult for millennials, who are starting careers and contending with student loans to get to a point where they can have that amount of cash just laying around.
It's even harder not to touch it.
Which is why I recommend for those battling large debts to build up to a simple $1,000 emergency fund. This amount can help keep you on track in the event of (most) emergencies. Having a small e-fund set aside can give you peace of mind while you funnel the majority of your cash to debt payoff. If you really work at it and be patient with yourself, it's pretty easy to get to $1,000 either by cutting back, finding money in your budget, or picking up a side hustle.
Once you've paid off debt, you can then work on getting to the recommended 6-9 months of expenses saved. Be gentle with yourself. A little bit set aside for a rainy day is better than nothing.
A Final Few Words on Emergency Funds
Most folks don't have an emergency fund. It's called living paycheck-to-paycheck and most live this way. Did you know….
- 61% of Americans live paycheck to paycheck. 1 in 5 of those makes over $100,000 each year. (That's bananas!!)
- 51% of Americans have less than one month’s worth of expenses saved up.
- 38% feel ill-prepared to deal with even a minor emergency (those costing ~$500 or less.)
…But enough fear mongering, there's enough of that in the news.
There is also an amazing psychological component to emergency funds; they're incredibly empowering. How would it feel to know that you could weather a storm or two (or five?) When an actual emergency happens, it's nice to not have to worry about the financial side of things because you're likely dealing with the emotional stuff, trying to find a new job, keep everyone calm. etc.
Forget about emergencies, as someone who used to be a financial sh!t show, I know what it feels like to have everyday money stress rule your life. It isn't fun and it tanks your self esteem. Putting a small emergency fund in place is a great way to start having your financial act together, and I'm not going to lie…it feels awesome.
This April, if you do anything at all for your finances, commit to starting (or funding if you already have one that's been a little neglected lately) your own emergency fund. You can thank me later.