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The Smart FI Sprint Episode 005: The Emergency Fund

in Personal Finance, Podcast, Savings
Emergency Fund Podcast
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Join me today as I discuss that enigmatic topic – the emergency fund! An emergency fund is a key piece of having a healthy and successful life. If you want to keep your stress about your financial position and your life to a minimum, the emergency fund will bestow a sense of ease. See below for the show notes and enjoy:

Smart FI Sprint Podcast Episode 005: The Emergency Fund

Update:

  1. This podcast is now officially on iTunes! So, if you can’t get enough of That Learning Guy, Financial Independence, or if you want to take the podcast on the go, head on over there to get more.
  2. Speaking of iTunes. I have started podcasting my writing on iTunes as well! If you’re interested, you can find the link in the show notes here.
  3. I decided I was sick of waiting for a “good time”, so I created my own website logo! Let me know what you guys think.
  4. I’ve given some of my podcasts another listen, and I think we need to amp up the energy in here!

Main:

  • With that, today we are going to discuss the enigmatic topic of the Emergency Fund!
    • You may know it by another name. It has been called the Rainy Day Fund, the Oh Shit Stash, Cash Reserve, etc., but we’ll stick to the name that is the most practical, the Emergency Fund
  • Background
    • This is a topic that is always debated since it has so many various dimensions. It sounds like it would be relatively straightforward, but you’d definitely be surprised.
    • Now, real talk here for a second. Let’s be honest, a lot of people don’t like the idea of an emergency fund. It takes away money from being able to consume/purchase things, and puts it in a place where nothing can be done with it, and it earns little – if any – interest. It looks like that money is just sitting there gathering dust. It doesn’t sound like a tantalizing prospect, especially when many people say you should have 6 or 8 months’ worth of those savings stacked up.
    • Let’s flip to the other side of the coin. Some people may not even have* the capability to save up for an emergency fund
      • * Almost everyone can save something, there is almost always somewhere to cut some fat.
    • There are various statistics/studies out there that have varying levels regarding emergency funds, but they all go something like this:
    • What’s up? Did people already forget about The Great Recession? I was only graduating high school when it hit, but after learning about everything, and knowing the direction our economy is going, what with increasing healthcare costs, rents, and more, I won’t be caught dead without an emergency fund, and neither should you.
    • If you put two and two together from the above information, a pretty unfortunate picture starts appearing. The reasons for peoples’ lack of emergency funds could be for multiple reasons. We can only speculate. Maybe it is because these people consume too much, maybe these people don’t have the ability to save after all other expenses are taken care of. Whatever the reason, I think it’s worth digging into and trying to figure out what the problem is so we can do something about it!
  • Well, you’re in luck, people! I’m going to give you lots of reasons why an emergency fund is a huge MUST, in addition to how you can save up for one, and the main and fringe benefits of having such a fund.
  • Why an Emergency Fund is a MUST
    • Let’s start with the basic, and perhaps most obvious reason, you lose your job.
    • Now, I know this is never a pleasant thing to think about. Nobody likes having their livelihood pulled out from underneath of them.
    • This can put stress on everything: relationships, your physical health, and more, but the main point here, is that it can be a huge strain on your wallet.
    • The emergency fund can prevent job loss from completely destroying your life. You will have the ability to keep putting food on the table, to keep paying the rent, and to keep the lights on while you search for a new place of employment. This is always a good thing. However, the emergency fund is also there in case of other problems, like – god forbid – potentially losing your home or you or a loved one falls gravely ill, and surprise medical expenses pop up.
    • Are you scared yet? Well, GOOOOOD! You should be. If you have no emergency fund, you leave yourself at the whims and mercy of the gods!
    • Whew, okay. Now that the gloom and doom is out of the way, let’s look at how you should go about starting your emergency fund so you don’t have to worry about a potentially catastrophic event!
  • Starting Your Emergency Fund
    • First, having and being able to have an emergency fund is all about priorities. Without priorities, having an emergency fund can be pretty tough work.
      • Just as an FYI, this is where having a budget comes in handy, that way you can see where all of your money is going, and that is more than half the battle
      • So, if you haven’t started a budget yet, check out my guide to budgeting! You won’t regret it. Find the link in the comments
    • You should store your emergency fund somewhere should be as liquid as possible. That means a checking or savings account, or a money market fund (as these three are the most liquid accounts you can have). You should be able to use a debit card, a check, or be able to withdraw the cash as soon as possible, thus the term, emergency. You want quick access/availability to funds during an emergency. If all of your money is tied up in stocks, bonds, property, etc., you most likely won’t be able to liquidate those assets fast enough (although stocks have become supremely liquid in this day and age).
    • The general rule of thumb for emergency funds is to have six months’ worth of expenses socked away somewhere. However, there is actually a hierarchy of priorities that needs to be taken care of that contains the emergency fund, but there are also several other factors that can influence how much money you can, or should, maintain in your fund. I’ll discuss this a little more in depth in a bit.
    • When starting your fund, you should also start small, especially if you are not used to saving, or you don’t have a high capacity to do so (like starting in a bad financial situation). Like with anything else, you don’t want to set too lofty of goals because it can be easy to burn out or quit before your reach them.
      • Tell yourself that instead of eating fast food once a week, you’ll put that $10 into your emergency fund/emergency fund account.
      • Before you know it, ten weeks later, you have $100 in the emergency fund. It may not seem like a lot, but that could be part of an emergency car repair.
      • Better yet, tell yourself that you will only go out to twice a month, cutting out an extra $80 of expenses every month
      • This combined with the $10/week saved from not eating fast food once a week will net you an extra $120/month!
      • You could do the same with a morning coffee. Buying starbucks every other day for $3? Cut that out and brew your own coffee at home, and sock the savings away. You’ll be amazed by what cutting out small things can do for your emergency fund!
      • Alright, now onto the hierarchy of things to consider when thinking about your emergency fund.
    • The Hierarchy and Things to Consider
      • Hierarchy
        • So, let’s discuss a loose hierarchy of the order you should consider using/saving your money that includes your emergency fund.
        • First, it may seem obvious, but you should focus on all of your bare necessities, such as your food, shelter/rent, gas, etc. Whatever you need to survive in your daily life. Once that is taken care of, you should then move on to
        • Saving up one month’s worth of expenses in your emergency, no questions asked. This is so you can cover the bare minimum in case of an emergency or a moderately large expense pops up. These can include you losing your job, sudden car maintenance, etc. Just enough to where you can hopefully find more work in a short period of time, or that a one-time cost won’t break the bank.
        • After saving up that one month’s worth of expenses in your emergency fund, you should focus on your paying down any high interest debt, such as credit cards, high interest loans, etc.
        • Finally, after paying down high interest debt, you should focus on getting a minimum of three months’ worth of cushioning in your emergency fund.
        • This should be a definite path you follow. You can play around with the formula a little bit, e.g. paying off three quarters of your high interest debt, then adding to your emergency fund, but I would stick as close to this loose hierarchy as possible.
      • Other things to consider
        • While hurrying to build up your emergency stockpile because you’re starting to freak out, I can tell you to slow down a little, take a few deep breaths, and try to consider a few other variables first. There are actually a surprising number of things that can affect how much you truly need in your emergency fund.
        • Does your household have two incomes coming in? If so, you may not need 6 months’ worth of an emergency fund. Maybe you only need 3 since if one of you lost your job, the other individual would still be bringing in a stable income. Obviously this dependent on how secure both of your jobs are, how much money each individual makes, etc.
          • If someone makes 60k a year and the other person makes 30k per year, and the person making 60k per year loses their job, it will probably be felt a little more strongly in the budget than the reverse situation.
        • The Benefits of an Emergency Fund
          • It may not seem like a lot of positives initially to having an emergency fund. However, once you start thinking about what an emergency fund really means, and what it can do, you’ll be happy you did it. Although you won’t be earning interest, dividends, or be able to spend this chest of dollars you’ll be sitting on, the intangible benefits are wonderful.
            • You can feel more comfortable about your job position. If you lose it, you won’t have to worry about taking out expensive loans or using credit cards to keep you afloat and alive. That way you don’t have to go into extra debt to survive, accrue interest, or spend someone else’s money.
            • If your car breaks down, you’ll have the money to get it fixed!
            • If you or a family member were to fall seriously ill, you’d have the money to cover that depressing circumstance.
            • If you can’t tell what links all of these items, it is the fact that you don’t have to worry. Your peace of mind should increase by a huge amount once you realize that you aren’t in terrible trouble if a large unexpected expense (not the roof collapsing!) pops up or if your job does fall out from under you (I’ve got three months to find a new gig!).
          • Our Emergency Fund as an Example
            • So, just to show you a real world example, we’ll use our emergency fund.
            • We currently have no high interest debt. The debts we are carrying are moderate to low interest rate student loans.
            • Because of this, we have been able to save up $10k in our emergency fund. If you’ve been following our expense reports, you’ll see that we spend about 4500-4700 dollars a month. However, this usually includes about $2100 worth of student loan payments a month. If we didn’t make any student loan payments, our expenses would be about $2500 a month.
              • Let’s consider a worst case scenario. If we both lost our jobs, that would give us 4 months of time for both of us to find a new job.
              • Now, let’s say we continue spending $2500/month, but we try to keep refreshing the fund with what That Learning Gal makes. So, we’re not saving anything, but that would be a much smaller net loss every month, which would dramatically extend the time I could look for a job. In theory (as long as we could abate student loan payments), it would extend my timeline from 4 months all the way up to 14 months.
              • Hopefully I wouldn’t need that much time, but we could have it! Then, on top of all of that, we could also reduce our expenditures in non-critical categories, such as eating out, personal things, reduce our energy consumption, etc.
            • So, as you can see, our emergency fund gives us a lot of flexibility, and abates almost any worries we would have about our job situations or our financial position.
          • Like I say, your money is yours to use how you see fit. All I want to do is try to help you set yourself to be as financially stable as possible, and I personally believe an Emergency Fund is a key part to feeling more secure in life. Like I stated earlier, the biggest asset of an emergency fund is the peace of mind which accompanies it.
          • As you can see, maintaining an emergency fund is a phenomenal idea! I encourage everyone to do it. I would command everyone to do it, but considering free will and everything, I can only encourage it as an extremely smart financial behavior.
          • Having an emergency fund is possible. It just takes time and dedication. In the future, I want to create a post detailing all of the possible ways to increase your emergency fund.
          • As always, I’m interested in hearing from all of you! Have you started, or do you have an emergency fund? If so, how many months’ worth of expenses do you keep in it? Are you more liberal with it, or more conservative? Why? Let’s talk about it in the comments. Maybe there are some best practices you all know that I may not have picked up on yet! Thanks again for listening everyone! And remember, keep calm and save on.

Sources:

http://www.federalreserve.gov/econresdata/2014-report-economic-well-being-us-households-201505.pdf

http://www.bankrate.com/finance/smart-spending/money-pulse-0115.aspx

http://www.bankrate.com/finance/consumer-index/many-americans-emergency-fund.aspx

https://investor.vanguard.com/emergency-fund/




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