Your Emergency Savings Fund – a Top Priority
Setting up your emergency savings fund should be your number one priority when you’re setting out on the personal budgeting road. This is the message you’ll get from just about anyone advising on money management.
But why is an emergency fund so important? Because it’s a key method to avoid taking on consumer debt. And when you take on debt you have to use some of your monthly income on debt repayments – which means you have less available to build your long-term wealth.
You’ll make quicker progress towards your financial goals and lifestyle dreams if you live within your means, become debt-free, and stay debt-free.
Monthly Cash Flow
To live within your means, you must spend less than your income. But some months your income may be lower than usual. And it’s almost certain that your total spend will vary from month to month.
Over the course of a year, these ups and downs average out. So, unless your income is way below average, you should be able to live within your means taking the year as a whole.
But the weekly or monthly picture can be quite different. Some months you can be hit by unexpected bills – or seasonal variations (school, festivities, heating). These are the times when you might wish you could reach for a credit card just to tide you over.
A credit card (or other consumer debt) is not the best answer.
In Case of Emergency, Break Glass
Imagine that you had put money aside into an emergency savings fund. You wouldn’t need to incur credit card debt. One month you may be short by $150. No problem, you just get the money from your emergency savings.
But you don’t touch those savings unless you have a ‘cash flow emergency’. When, if you didn’t use your emergency fund, you’d have to take on debt.
Think of it like those signs, ‘In Case of Emergency, Break Glass’. What you don’t want behind the glass is a credit card. You want a savings fund. So, the sign would say, ‘In Case Spending is High This Month, Borrow from My Emergency Fund’. Of course, once you've dipped into your emergency savings, you need to build them back up.
How Much Do You Need in Your Emergency Savings Fund?
The number one priority is to get something along the lines of $500-1,000 in an instant-access account (or even cash – provided you don’t fritter it away). You can choose whatever figure you like once you understand the concept. How much do you think you would need, bearing in mind you might have a tough run of several unexpected bills?
In the longer-term, it’s good to build up your emergency savings account so it covers several months of living expenses. This would help if your main source of income came to a sudden halt, and you had to look for a different way of earning your living.
But to start with, you want enough for the smaller emergencies.
Finding the Money for Your Emergency Savings Fund
Remember that you may need to get at these savings at any moment, so avoid using bank accounts where you must give notice to withdraw monies. On the other hand, if you currently have savings in that sort of account, you could give notice to withdraw say $1,000 and transfer it to a new instant-access account.
Or you may own items of value that you can sell. These could be everyday items you haven’t used for a while. Or you could even ditch an expensive car and buy a cheaper one. It’s all about deciding on your priorities. What’s important to you, and what are you happy to let go in search of a better future.
If you don’t have valuable assets to sell, or don’t want to sell them, you can build your emergency fund by living within your means for several months (as long as it takes to reach your target amount).
Saving Monthly Step-by-Step
With this strategy, you have two possible approaches:
- An emergency budget – this is like a sprint. You cut back in a big way on your spending for a short time (say two months) to build your emergency savings fund. For example, you might stop eating out, cancel streaming subscriptions, and put a stop on any purchases that you may want but you don’t need.
- A steady budget – more like a marathon. You retain some of your current lifestyle spending (using the 50-30-20 principle, for example). But you ensure you live within your means and build your emergency fund more slowly.
If you opt for the emergency budget, you can switch to the steady budget once you’ve built your initial emergency savings goal.
The danger is that, until you have your emergency savings fund in place, you may be hit with unexpected bills. If you don’t want to reach for the card, it’s best to build the fund as a top priority.
Should You Repay Your Debts Before Building an Emergency Savings Fund?
For most people, the answer is no. The top priority is to set aside something like $500 (ideally more) that will be your fallback money. If you want to become free of any consumer debt – an excellent long-term financial strategy – the last thing you want to be doing is taking on more debt.
So, for most people, step one is to build sufficient emergency savings to cover relatively small, unexpected bills. Then you can move onto paying off your debts. And then, when you’re debt-free, you can build your savings to much higher levels.