How to Build an Emergency Fund
If you’re struggling to get control of your finances, it’s an absolute necessity figure out how to build an emergency fund. That’s because you need to stop using credit cards. You’re in debt now because you used credit cards. They aren’t a solution, they’re a problem.
“Do what you’ve always done, get what you always got.”
If you want your finances to be different. You need to change something.
You tried using credit cards. Credit cards brought you nothing but debt and “junk” filling up your house. So, now we’re going to change that. No more credit cards. Ever.
Without an emergency fund, as soon as something goes wrong in your budget (which it will frequently), you’ll go right back to the credit card.
Let me be perfectly clear. If you’re in debt, you must stop using credit cards. You will never dig yourself out of this mess without ditching the credit cards. You are not the exception to the rule. You are the statistic.
If there’s one thing I can promise you that will happen, it is that you will go over budget. If you’re new to this, you will go over budget frequently. You need to be prepared and know exactly what to do when that happens. BEFORE it happens. You can find your game plan for that here.
You also need to have money set aside so that when life doesn’t go as planned, you have options other than the credit card. Hence, the emergency fund.
The secret to actually creating and keeping your emergency fund is to feel “poor”, even when you have money.
You and I, we got into debt because we spent what we had, plus a little extra. Sometimes, a lot extra. 76% of Americans today are living paycheck to paycheck (Source: CNN). That means that 76% of us have no idea what would happen if we had a true emergency and had to come up with a lot of money quickly.
While my own finances don't keep me up at night any longer, that statistic does. That 76% consists of parents whose babies are counting on them and whose children are learning from them. They’re men and women who have worked their whole life and have nothing to show for it except Vera Bradley bags and Ikea furniture.
I know how scared they must be, and how much they want to change but they don’t know how.
Here’s the secret. Life will never be predictable. Ever. That’s okay, we can handle that if we think ahead.
Why you spend your emergency fund:
Most people can’t figure out how to build an emergency fund because they’re used to living paycheck to paycheck. .
They’re totally ok with a checking account that has $100 in it until the next payday. They’re used to it. When they get extra money, it makes sense to spend it. They earned it, they deserve it. I know exactly how that feels, because that was me.
We can’t change the way you feel about that. Your views on money were set in stone long before you met me and they won’t change without a strong motivating factor (usually fear). Even if you swear right now and commit yourself to saving your extra money into an emergency fund, you won’t do it.
Right now, you're committed to this because you're reading this. In a week or two, when you have extra money, and your friends ask you to go to the movies.. You’ll think “I can probably swing that”… and so on, and so on.
This is why you’re poor.
There is nothing wrong with you. This thought process is normal and doesn’t define you. But you need to accept this about yourself.
You will not change your life with a sudden burst of discipline. You will change your financial future by knowing your weaknesses and then working around them.
How to not spend your emergency fund:
You’re going to pay your emergency fund like it’s a bill. It’s non negotiable. Sit down right now, and open up a “hard to access” savings account. My favorite ones, are online banks (make sure it’s an FDIC insured bank obviously) like Capital One 360 Savings, where it will take you time to transfer the money to your regular account.
You’re going to set a date on your calendar and auto pay a certain amount every month to that checking account. Then you’re not going to think about it in the slightest. If an emergency happens, you’re going to do you best to handle it within your budget. I want the emergency fund to be a last resort, just like your credit cards used to be.
What happens in an emergency?
I want the emergency fund to be a last resort, just like your credit cards used to be.
Is there a way that you can make extra money this month to take care of that emergency? When we were in that situation, we would go through and declutter the house and sell anything we weren’t using. We rolled change, we did extra tests at User Testing (they pay $10 for a 15 minute test).
Does your work have overtime available? Can you pick up a side job? Look for those solutions first.
Can you reduce your spending in a budget category and use the savings to handle the emergency? Reducing your grocery budget is the easiest place to make up the extra money, but can be the hardest if you aren’t organized yet.
If all of those won’t cover it, then I want you to sit down and think long and hard if this is an emergency. I’ve heard of a lot of “emergencies” that aren't emergencies.
Here’s a few examples:
- We’re supposed to go on vacation with friends.
- I promised my daughter a laptop.
- We need to buy Christmas presents.
- Wedding expenses
- Bridesmaid expenses
What will happen if you don’t pay for this? Are you afraid to disappoint friends and family? If they were truly friends and family, they would want you to get your money under control. If they’re upset at you… you haven't lost a friend, you’ve just gained clarity. If it’s definitely an emergency, then go ahead and use your emergency fund.
What if even my emergency fund won’t cover it?
If you’re 100% certain that it’s an emergency (feel free to email me if you aren’t sure… I’ll tell you!), then use the emergency fund, reduce your budget, make as much money as you can and see if the company you need to pay will work out a payment plan. If they won’t take a payment plan and this absolutely can not wait… Do what you need to do and mitigate the damages as much as possible.
How much should I have in my emergency fund?
$1,000 is pretty standard (thanks to financial guru Dave Ramsey), but some people may need more than that. $1,000 was plenty for us, but you may need more.
A friend's family has 2 teenagers, a very old house and they are going through a divorce and child custody battle. The potential for financial disaster and really expensive emergencies with them are extremely high. For them, they would need to aim closer to $5,000 to have the same amount of peace that we had with $1,000. In fact, they saved $1,000 and had the top floor of their house cave in and then got an unexpected $2,000 bill from an attorney.
Start with $1,000 but if you have a situation that could get expensive, I want you to aim a little higher.
What if this plan didn't work?
Then you need to distance yourself from the money even more. Talk to your employer about direct depositing a percentage of your paycheck in the savings account. That way you never even see it. You’ll adjust to the new paychecks and move on.
I know this doesn't sound fun, but the things that this will bring you are so worth it. Once you have your money under control there are no limits to what you can have or achieve. If you want to spend a month backpacking through Europe, you can. If you want to have a lake house, you can. This won’t be easy. It will be worth it.
You can do this. I can help.