I’ve been focusing on the Baby Steps to financial freedom the past few weeks. In case I forgot to mention this, the first three #BabySteps should be done one at a time and in order. This may seem ridiculous but trust me, this works. The other four Baby Steps that we will talk about can be done all at the same time if you want. More on that later.
This week’s Baby Step is to fully fund your emergency fund. What does this mean? Remember on Baby Step #1 we were saving a starter emergency fund? A great place to start for this starter fund is $500 for an individual or $1,000 for a couple.
While this a great “starter” fund, it isn’t enough to sustain things like a short-term disability, job loss or change, or an emergent car repair or replacement. You may be wondering, “how much is enough?” My clients and I talk about this all the time. I recommend saving 3-6 months of your EXPENSES, not your income. The idea here is that you’ll have enough to cover lifestyle while going through the emergency itself. It’s one less thing you’ll have to worry about.
For example, let’s say your take-home pay (your net income) is $4,000 a month. But your monthly expenses total $3,500 a month. You would want to save up between $10,500 and $21,000. This may seem like a lot of money. Clients have seen how fast it adds up when you’re not paying with credit card companies anymore and saving for yourself!
Clients also wonder where they should save this money for their emergency fund. Should it be in an investment account or a money market account? The truth of the matter is that you’re saving the money for an emergency meaning you need to be able to have immediate access to it. I’m not a fan of storing it in a shoebox under the bed, but at your local bank or credit union would work just fine.
I do recommend keeping it in a separate bank account or maybe even a separate banking institution to create separation between your everyday checking account and this emergency fund. This may be unpopular, but this money is not meant to be an investment. It is meant to protect you and your family. It’s meant to keep you from racking up credit card debt when you’re just worked so hard to pay if off.
One thing to remember is that if you dip into your emergency fund, no matter what Baby Step you’re on, it is recommended that you save and refill the fund before moving forward on the next Baby Step.
If your take-home pay were $4,000 a month, what would you want your fully funded emergency fund to look like? Email me at email@example.com.
I’ll go first. My husband and I settled on 4.5 months of our monthly take-home pay.
Image credit: Inc. Magazine