There’s no better time than the approach of a new year to take a good look at your finances and figure out how you can improve your financial picture for the coming year. Part of a solid financial picture and plan is the creation of an emergency fund. Mike talked last week in this post about how his emergency fund saved his tail when they had a large, unexpected home repair emergency. Grayson has written before about the true importance of an emergency fund, and how one can really mean the difference between overcoming trouble and being overcome by trouble. Today we’re going to give you 4 easy steps for creating an emergency fund for your financial plan.
Building an Emergency Fund in 4 Easy Steps.
1. Determine the Amount You Want in Your Emergency Fund.
The general consensus by financial experts and personal finance bloggers everywhere is that an emergency fund should have no less than three months’ worth of living expenses, and preferably, six months’ worth of living expenses. Only you can determine how much you need and how much you are comfortable with having in your emergency fund, but it’s important to think “big picture” and long-term when planning the amount you’ll put into your emergency fund. For instance, if you were suddenly laid off for your job, how much money would you need to live each month, and how long could it realistically take for you to locate another job? These are the types of questions you’ll want to ask yourself when deciding just how much money you want in your emergency fund. Other factors also can determine how much money you want in your emergency fund. For instance, if you’re working on getting out of debt, you might want a smaller emergency fund in order to focus most of your funds toward paying off debt. However, if you know your job with be eliminated in a year, you might want to aim to have that six month emergency fund as soon as possible.
2. Open a Separate Account for Your Emergency Fund.
Your emergency fund should be in a liquid, safe, easily accessible account. The stock market is not the place for your emergency fund, as it can disappear with one fell swoop of a stock market crash. A basic savings account or similar account where there are no fees or time requirements for withdrawing the money should be considered when looking for a home for your emergency fund. Don’t worry about earning interest too much, as growth and interest earned is not the purpose of the emergency fund. Instead, its purpose is to have quick, easy access to cash in the case of a financial emergency.
3. Determine What Your Emergency Fund Will Be Used For.
It’s important to make sure you’ve got a set plan as to what your emergency fund will and will not be used for. An emergency fund is not meant for vacations, new furniture or “gotta have it” clothing or electronics sales. An emergency fund, as Mike talked about here, is for unexpected, necessary-to-survival type emergencies. Make sure you have those types of emergencies determined before you establish your emergency fund, so that there’s no temptation to use it on a spur-of-the-moment trip to Bora Bora.
4. Make a Serious and Determined Plan to Fund your Emergency Fund.
In order to establish your emergency fund quickly, it’s vital to make it a top priority in your financial life. Search your budget for unnecessary expenses, and consider cutting those expenses for a short time until your emergency fund is fully funded. Put overtime earnings, tax returns, money from selling unwanted items, and all other “extra” funds toward the emergency fund until it reaches your designated amount.
An emergency fund might seem like one of those “I’ll do it someday” items on your financial planning list. However, those who’ve incurred large, unexpected expenses know the value of having cash set aside and ready-to-use in case an unexpected expense pops up.
Do you have an emergency fund? What’s your biggest financial goal for the new year?
Image via StockMonkeys.com, modified by me!
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