Several months ago, I started a series called, “7 Simple Steps to True Financial Freedom.”
In this post, we’ll cover step 3, “Establish an emergency fund.”
We’ll talk about what an emergency fund is and why you need one, how much you should have in yours, where this money should come from, and where to put it once you have it.
Before we get started though, just as a reminder, below is a brief outline of the steps I mentioned in that original blog post…
1. Start with giving.
2. Take care of the basics.
3. Establish an emergency fund.
4. Wipe out high-interest debt.
5. Add a rainy day fund.
6. Reach your long-term goals.
7. Don’t stop giving!
Over the past few months, we’ve been looking at each step of The Stewardship Plan™ in detail, so you can learn how to make 2016 your best money year yet!
Now that you’re up to speed, let’s get started…
What is an emergency fund?
An emergency fund is like the sandbags folks use to keep the floodwaters out.
It’s not a permanent solution, but it buys you some time until you can put together a better plan.
Financially speaking, when you establish an emergency fund, it won’t be very large when you first start out.
Until you payoff high-interest debt (the next step in The Stewardship Plan™), you should only worry about setting aside enough money in your emergency fund to help cover relatively small, unexpected financial emergencies.
This way, your debt payoff plan isn’t derailed if you have an unexpected expense pop up from time to time.
If you don’t have an emergency fund, these relatively small financial emergencies could cause you to backtrack on your debt payoff plan and you might lose all motivation for continuing forward on your journey to true financial freedom.
How much should be in your emergency fund?
For most folks, an emergency fund should have enough money to cover your auto, homeowner’s, and/or health insurance deductible.
Typically, that will be somewhere between $500 to $5,000 or so for most people.
When you think about it, this amount makes complete sense. After all, most one-time financial emergencies are in this range.
Fender bender while doing some last minute Christmas shopping?
Roof leak from tropical storm Billy Bob?
Busted water heater the day before Thanksgiving?
Unexpected health insurance copay for last week’s trip to the ER?
You got it! These unexpected expenses are all likely in that $500 to $5,000 range.
Where should this money come from?
Depending on your income, you might be able to fund your emergency fund by setting aside money from each paycheck for the next 3-6 months.
If you think it’ll take longer than that (and even if it won’t) it’s probably time to start thinking about selling a few things!
Personal finance author and radio personality, Dave Ramsey, says it best when he routinely tells audiences to, “Sell so much stuff the kids will think they’re next!”
Although I don’t agree with everything Mr. Ramsey recommends when it comes to investing and financial planning, he’s spot on in this regard.
Where should you put your emergency fund?
The key to only using this money for actual emergencies is to make sure it isn’t easily accessible.
Typically, an online savings account or bank certificate of deposit (CD) with little to no early withdrawal penalty is going to be your best bet.
Bricks and mortar banks and credit unions are fine too, but they typically pay lower interest rates, so it’s worth shopping around and finding the best deal before deciding where to park your hard-earned cash.
Why can’t you leave this money in your checking account?
Because the LAST THING you want to do is go through the hard work of saving up money in your emergency fund, only to “accidentally” blow it on a sale at Golf Galaxy.
Who knew that extra $1,000 in your checking account was your emergency fund, instead of extra money for a new set of irons.
Not that that’s ever happened to me or anything…
After the emergency fund…
So, you’ve sold some stuff and saved up some money in your emergency fund.
Great job!! But what next?
That brings us to step 4…wipe out high-interest debt.
During our next post in The Stewardship Plan™ series, we’ll talk about what’s actually considered “high-interest” debt and we’ll cover how to get rid of it.
Until next time, click here to email me with any questions or use the sign-up form below to have the next blog post delivered straight to your inbox!