Life happens, so save for emergencies! We never know when something crazy is going to happen. Strategically Saving is all about being prepared for unexpected events. So, let’s transform life’s emergencies into inconveniences.
Many times, my clients will dwell on past events that have happened to them. Emergencies that “caused” them to borrow money or go into crisis mode emotionally. Life happened to them and they were not prepared. They did not have a firm foundation in place.
Always remember that we need insurance to defend our Inflow against the big stuff. That is why it is critical that you have the proper amount of coverage for your car, for your house, for your life, etc. But, don’t let the small stuff become a big deal by not having an emergency fund.
Normal is Not Good
As Dave Ramsey always says in his book The Total Money Makeover, “Normal is Broke”. The last thing you want to be is normal or average, in America at least. Most Americans are walking around with little to no money. We simply don’t save for emergencies.
According to Bankrate’s Financial Security Index survey, from January 2018, “More than one-third of [American] households, 34 percent, endured a major unexpected expense over the past year, … with only 39 percent saying they would cover a $1,000 blow with savings.” (Bankrate)
Sixty-one percent of Americans have less than $1000 in the bank? Then how would they deal with a little emergency? How will they be able to pay the deductible on the insurance claim when they get into a car accident, or their house’s roof leaks, or when that medical issue pops up? As, the statistic states, one-third of the population will have one of these occurrences in the next twelve months!
“Credit”, states the Bankrate article. Debt was many times the answer. #sadface
As Dave Ramsey says, “the worst time to go into debt is in the midst of an emergency”. Yet that is exactly what normal people do.
It’s time to stop this madness.
How Much to Save for Emergencies?
The key here is that your emergency fund will change depending on what stage you are in life and how much Inflow you have. This is similar to how the types and amounts of insurance changes as your assets an age change. Budgeting is certainly a prerequisite to apply this strategy and hitting the target.
NOTE: I teach this principle just like it is laid out in The Total Money Makeover because it works! I use it, and it has been a blessing to all my coaching clients. (The same reasons I became Certified as a Ramsey Financial Master Coach).
Here is the blueprint:
- Keep $500 set aside if you are still in debt and your household income is less than $20,000 per year.
- Save an emergency fund of $1000 if you are still in debt and you have an annual household income greater than $20k.
- Make sure your emergency fund has an amount equal to 3-6 months of expenses if you are completely out of debt, except the mortgage.
So, as you can see, you may fall into any of the 3 levels of emergency funds.
The first two are very straight forward. If you are in debt, you need to have an emergency fund, but not a fully-funded emergency fund. The power in having this beginner emergency fund is that you have the rest of your income to demolish debt.
Baby Step 1: As taught by Dave Ramsey
Sometimes I will have someone question this strategy. They may think that it is not worth having money just sitting there when it could be paying down debt. This is a bad decision because, without this starter emergency fund, you are exposed to mini-attacks. Like I said, life happens, and you need to be ready for it.
Others want to save more than $500 or $1000 because they are afraid that it will not be enough. The truth is, yes, it is going to rain, and Murphy is going to come for a visit. But, if you have the proper insurance in place, with deductibles set accordingly, you will rarely have an emergency that exceeds this amount. If you are afraid that $1000 is not enough, don’t worry. I will address that fear by the end of this post.
The point is to have this cushion, just in case, while you are demolishing debt with a vengeance. The only time I’ve seen this formula not work is when the person is not sick and tired of being sick and tired. For example, they don’t want to aggressively demolish debt. They instead want to casually tip-toe out of debt. Get out of debt as fast as possible, so that you can have all your Inflow to save up for a fully-funded emergency fund.
The Fully-Funded Emergency Fund
When you are ready to save for emergencies post-debt, it’s time for a fully-funded emergency fund. And it has a range as you can see. It could be anywhere from 3 to 6 months of expenses. Many people seem to be confused with this range wondering how much money that adds up to.
You must have a budget to know what an average month of expenses is. I ask people all the time, “How much do you spend on groceries … utilities … leisure …”, and I many times get a blank stare. They don’t know. If you don’t know, read my blog post Achieve Your Financial Goals Faster.
Once you know how much you spend in a month on average, you can multiply that amount by 3, 4, 5, or 6. So, which number is the right one for you?
Right Size Your Emergency Fund
I always point to two factors of your Inflow. (1) How many streams of income do you have in your household and, (2) how stable are those streams?
If you only have one stream of income, you need to have a six-month emergency fund. Why? Because, if that income goes away, you will have lost 100% of your income. If you have two streams of income, I usually suggest the same; save for emergencies that could last for up to six months.
When you get up to 3-4 streams of income in the household, I recommend having at least 5 months. At 5-6 streams, 4 months. With 7 streams or more, you are safe with 3 months worth in your rainy-day fund.
Adjust these guidelines according to the quality of those streams of income. For example, if you 3 streams of income, but one of them is a 100% commission job, you should go with a 6-month as opposed to a 5-month fund.
The stability of these income streams may be affected by the stability of the source. Is your employer a stable company? Do you have your own business? Go with the number that makes common sense for your situation.
I know many people who error on the side of having more than enough and keeps 6 months at the ready no matter how much income they have.
Save for Emergencies Fast!
Do not make the mistake I have seen so many times: saving up the emergency fund over too long of a period. Make sure that you do this with all your focus.
If you are saving for the starter emergency fund of $500 or $1000, because you are still in debt, you may already have it in the bank. I’ve coached people who have a savings account with a few thousand dollars. And they are in twenty thousand dollars of debt. In that case, withdraw all but the starter emergency fund amount, and use the rest of the cash to apply to your debt demolition plan.
If you are out of debt, you have graduated to a fully-funded emergency fund. Get it done quickly! Once it is fully funded, you don’t have to add to it ever again unless you have had to tap it for a real emergency. If you take too long to build up this fund, you will struggle to finish it off.
Everything Else Can Wait
You have no debt. That means that the only money you must spend is on true necessities (i.e. rent, transportation, utilities, phone, clothing, food, etc.) No, you don’t really need to go on vacation right at this moment. You may feel like it, but you don’t.
I don’t want to just pick on vacations, but it is a good example. Taking a holiday is an extraordinarily important (and expensive) expense that can seem like a necessity right now. But, saving for emergencies is more important, believe me.
We made this mistake. After a long battle, living on bare necessities, eating food for as little as money can buy, never buying a new piece of clothing, and of course, taking no vacations … I NEEDED A VACATION REALLY BAD. So, we decided to take a vacation to Washington D.C., and celebrate kicking debt out of our lives forever … right in the middle of building our emergency fund.
Do you want to guess what happened?
Do Not Tempt Fate
No, we didn’t have a major emergency on vacation. Though, this is what has happened to people who have not saved up a fully-funded emergency fund before going on a vacation.
Imagine being in Cancun. The plane lost your luggage. You dropped your cell phone and it is damaged beyond repair. Your wallet has come up missing. Insurance is only going to come into play after you have forked over a few hundred, maybe thousand, bucks. That would suck!
Anyways, we came back from our D.C. vacation, relaxed and ready to get back at the goal of building a $10,000 fully-funded emergency fund. But, a medical bill came in for a surgery I had 5 months ago. Then the furnace went out, because the furnace always goes out when you don’t have an emergency fund. Then my Post 911 GI Bill funding ran out right before the last class in completing my MBA degree. That left me with a $2,800 bill. Now I know what GI Bill stands for: Giant Inconvenient Bill.
I keep thinking about the fact that if we didn’t go on vacation, we would have had exactly the amount of money to pay all of these “surprise” expenses. We would have been able to save for emergencies, 6 month’s worth, fully funded by Christmas. Instead, it set us back 3 months.
Save for Emergencies! Heed My Warning and Do it Today!
Believe me, anything could happen, so do it ASAP. I’ve seen people sell something for a thousand bucks to get over that last hump. Get a second job for 3 months and knock it out! Cut back on the lattes for a little while, just to put the finishing touches on the mega important component of your financial foundation.