Topics we discuss below
Before the Savings Plan
You can't talk about saving without talking about budgeting. The two topics go hand in hand. Strictly speaking, you could make the decision today to save a certain amount without a budget, but you'll either end up dipping into savings later that month or you won't be maximizing your savings and investment opportunities.
If you haven't been through our budgeting section, you may want to start here.
Before retirement planning or considering investment opportunities, you’ll want to build a financial cushion for the unexpected. We all need this safety net, regardless of income level. There are black swan events in everyone’s life—car accidents, medical bills, job losses, flooding basements, and a hundred other curveballs.
When these catastrophes happen, you will dip into this fund for emergencies. Having it will insulate the rest of your finances from the devastating effects of these disasters.
What Your Emergency Fund Should be Used for
Emergencies comprise a very narrow category. They are unforeseen and unpreventable.
We all have to remind ourselves that a vacation is not considered an emergency, no matter how stressed out we’re feeling. Vacations and regular maintenance should instead have a distinct place in your budget. Reserve your emergency fund for true emergencies.
Emergency Fund Goal
Setting a goal of 3 months of income in your emergency fund is a good place to start. Once you have achieved that, try and increase the fund from 3 to 6 months’ worth of salary. These aren’t arbitrary numbers; most long-term disability policies don’t kick in for 90 days, so you’ll be waiting 3 months before you are eligible for payments. Another reason for having 3 to 6 months of expenses on hand is to cover an extended period of unemployment.
When determining how much to allot for emergencies, check you’re deductible on your insurance policies (home, car, and medical) to make sure you can cover the out-of-pocket amounts on these policies.
What Happens When You Don’t Have an Emergency Fund in Place?
Without an emergency fund, your financial situation can snowball quickly. Those of us without an emergency fund may use a high-interest credit card to cover immediate expenses.
Over time the unforeseen occurs again and again.
Consider the infographic. As far as the unexpected, many of us would consider the expenses shown above as a 'good year'. These expenses, totaling $3,640, might occur over a year, 6 months, or even an unlucky month.
We may not know when these expenses will occur but we do know that expenses like these WILL happen. The emergency fund is there to prevent you from going into debt when these situations arise.
Out of Sight, Out of Mind
Keep your emergency fund out of sight. If you don’t look at your emergency fund every time you access your checking account, it will be considerably less tempting to dip into that account. Out of sight, out of mind goes a long way to keeping you on track.
Earning Interest on Your Emergency Fund
There are many ways to generate interest from your emergency fund.
The money can be placed in a savings account, money market account, or a taxable investment account in very low-risk assets. All of these accounts can be accessed quickly.
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