Disclosure: For Educational Purposes Only – Not to be relied upon as financial advice. The views expressed are those of the author/presenter, and data is derived from sources believed to be accurate.
How to Start an Emergency Fund
I truly wish that money didn’t hold the social importance that it does. However, the inescapable fact of the matter is that, in order to live comfortably in today’s fast changing world, each of us needs some level of financial security.
As a financial advisor, I see far too many people work far too hard, for far too long with little-to-nothing to show for it all. For the majority of people, all they have to show for all their years of hard work are the things they’ve purchased for themselves over the years.
In fact, the 2016 U.S. Census Bureau reports that the median household net worth for homeowners age 65 and older is only $209,300. If you removed their house from the figure, it would only be $64,370.1
The median best represents the middle point, where half of the households have more and half of the households have less. In a mathematical average, your top one percenters in the country would greatly skew the numbers.
I consider an emergency fund to be one of the three money buckets required to build wealth. [deep link to post] To me, wealth is more of a number than a dollar figure. That number represents the number of months that I can live without having to work a job.
Unfortunately, you can’t build wealth for yourself if your solution to financial problems is to resort to debt and liquidate the investments that you’ve worked years to build. So to help you change this dangerous mindset, I want to share this Emergency Fund Guide for Beginners.
What’s an emergency fund?
An emergency fund is a bank account earmarked to cover larger, unexpected expenses that you can’t pay for with your income. The keyword here is “unexpected.”
Here are some examples of how people use money in their emergency fund:
- Loss of income
- Car repairs prohibiting from commuting to work.
- Expenses related to the death or illness of a loved one (e.g. flights, hotel, etc.)
- Events leading to unsafe living conditions (e.g. water heater, leaking roof, etc.)
- Repair or replacement of a broken appliance (e.g. refrigerator, washer/dryer, microwave)
- Any unexpected bill that can’t be paid through your cash flow (e.g. IRS bill, medical bills).
There are a lot of situations where you should use an emergency fund and they can’t all be listed here. Just remember that it’s for an emergency and a last resort.
Here are some examples of non-emergencies:
- Not having enough money for the holidays
- Unexpected invitation to go on vacation with friends or family
- Losing your job and not having enough money to buy non-essential items (e.g. nothing related to groceries, utilities, shelter, or transportation to work)
- Purchases where you’ll put the money back next paycheck.
It’s crucial to not use or borrow money from your emergency fund for things that are not an emergency. I promise you that an expected bill or collections notice will show up in the mail right after using your emergency fund for something dumb. I’ve seen it happen too often and it’s even happened to me, of all people.
Who needs an emergency fund?
I’d like to believe that we all need an emergency fund, regardless how much income we make. Emergency funds create a cash cushion that can help us through tough times, without having to always resort to debt to fix our financial problems.
If you look at what has happened across the United States with the Coronavirus (COVID-19), the virus has crippled our economy. Millions of people lost their jobs, incurred medical bills, or at the very least experienced a reduction in their income.
Thankfully the government intervened, providing stimulus checks and small business loans to make sure that employees keep their paycheck. But what if this only happened to your family? How long would you survive without income and where would the money come from?
You can’t rely on the government to bail you out.
How much should I have in my emergency fund?
Short answer: You need a minimum of $1,000 in a starter emergency fund.
When you’re just starting out with building an emergency fund, your first goal should be to save $1,000 as fast as you can. If the account drops below that amount (because you had an emergency recently), you need to build it back up to that minimum level —fast!
Is $1,000 enough? The simple answer is no.
You eventually need to build this account up enough to cover 3-6 months worth of expenses, and that takes time. The importance of having a thousand dollars in this account is more for psychological reasons, but it helps you avoid more debt.
If you look at how the government approaches budgets, it’s a “use it all or lose it next round” system. In other words, people are punished if they’re fiscally responsible. They won’t get more money next round, if they don’t use it all.
Because of that, we’re trained as consumers to spend all of our money. Naturally, when a problem arises, we resort to debt to cover the shortfall or tap into our retirement accounts. Coincidentally, the government does the same thing.
Currently the U.S. national debt is almost $24.5 trillion dollars and our government is dipping into federal retiree programs to help fund operations. The government is in debt and it’s tapping into retirement money.2
Having a thousand dollars in an emergency fund changes the way you handle financial problems. You start to think differently about your money when you give each dollar a job. The goal is simply to avoid debt as a first resort.
Debt is a thief and it will steal all your hopes and dreams. The more monthly payments you have to make, the less of your paycheck you get to keep.
Is an emergency fund a bank account?
An emergency fund is a bank account, but earmarked for emergencies. Because an emergency fund is critically important to avoiding debt, I don’t recommend keeping yours at the bank that you pay bills out of.
I’m a spender, so what works for me is an “out of sight, out of mind” approach. I like to know that the money is there if I ever need it, but don’t want to see the balance every day. And for that reason, I keep my emergency fund, as well as my other sinking funds, at an online bank.
I do this for a couple of reasons. First, if an emergency were really to happen, the money can be wired to my bank account within a couple of days. And second, this affords me time to process the situation, and do some critical thinking.
My wife and I have been in a number of situations that felt like an emergency. Thankfully, we have an amazing relationship and schedule Money Dates to talk things out. But most of the time we come up with a solution that doesn’t involve our emergency fund. We have several sinking funds like our vacation fund, 5-Year Goals fund, kids activities, even a boat fund. We can borrow between each of the accounts before ever needing money from an emergency fund.
I’ll be honest. I have a boat fund and it’s a bad financial decision to get a boat. Sure, if I have the money to make those kinds of decisions, then great. But for now, if I have an emergency that’s the first thing that’s gonna go.
If you’re ever faced with an emergency, talk things out with your partner and make financial decisions together. Even if you made the wrong choice, at least you both get to learn from it. And that lesson is worth some money.
And just know, real emergencies rarely ever need to be resolved on the spot. They can wait a couple of days.
How to start an emergency fund
Okay, you want to start an emergency fund, where do you start?
First, choose a bank or credit union that’s separate from the one that you pay bills out of. As I mentioned earlier, I recommend online banks that have no minimums and no monthly fees. They typically offer exponentially higher interest rates on savings and money market accounts, with some even offering interest on checking accounts!
If you already have an emergency fund at a local bank, I leave it up to you to decide if you want to keep it there or move it online. In either situation, cut up any debit cards that you receive. You want to add extra steps, even days, to afford you time for critical thinking about your emergency.
Next, you need to fund your emergency fund. Because, what good is an emergency fund with no money in it? Your goal is to save up $1,000 as fast as possible, and that will require a radically different mindset than you have today.
If you wait until the end of the month, you’ll always find there’s nothing to save. That’s because you have this mindset of paying other people first. Instead, I challenge you to flip that around and pay yourself first.
Paying yourself first is where you take a portion of your paycheck and add it to your emergency fund before paying any bills. It’s the practice required not only to build your emergency fund, but also to build wealth. But it does take some budgeting.
If you need help finding some money, I created a 30-Day Money Finder Challenge that’s helped hundreds of people build their emergency fund, as well as improve their personal finances.
You’ll get 30 days worth of financial tasks, dripped to you daily via email. Most tasks only require as little as 15 minutes, with the average person saving $500 by the end of the challenge. That’s half of your emergency fund minimum.
- An emergency fund will help break a financial fall due to an emergency. We all need one or else we’ll always resort to debt to fix our financial challenges in life, and that won’t help you to build wealth. Debt is a thief that robs you of all your hopes and dreams.
- A starter emergency fund needs to have a minimum of $1,000 in it. If you need to use some of it for emergencies, don’t feel bad. That’s what it’s there for. But you need to make bringing this account back up to $1,000 a priority.
- An emergency fund is a savings account, preferably at an online bank or credit union. Online banks tend to offer higher interest than local brick and mortar banks. Also, they don’t usually have debit cards and take a couple of days to wire the money. This affords you time for critical thinking, allowing you not to respond emotionally.
- To fund an emergency fund (and keep the money in there), you’re going to have to think radically different than you do today. You’re going to need to pay yourself first, which will require you to do some budgeting.
- You have a friend to help —me. I have created tools and resources designed to help, like my 30-Day Money Finder Challenge. If you want to chat, connect with me on Facebook or Linkedin.
1) Wealth, Asset Ownership, & Debt of Households Detailed Tables: 2016, U.S. Census Bureau — https://www.census.gov/data/tables/2016/demo/wealth/wealth-asset-ownership.html
2) U.S. Department of the Treasury, Bureau of the Fiscal Service — https://www.treasurydirect.gov/NP/debt/current