Start a six month emergency fund? Are you crazy? How can I save that much money before I start investing? I’ll never make it! – most common reaction to my advice to create an emergency fund.
Personal finance is fun, but maybe the most boring part is creating an emergency fund. Yawn.
Building an emergency fund should be exciting. Sure, it’s the bland foundation of the house, but once this baby’s built, you’ll be able to rock ‘n roll on the fun stuff:
– Work without worry. You’ll know that even in an uncertain economy, you can focus on career instead of your next paycheck.
– Invest with confidence. We’re all worried about the market collapsing, but the best strategy is often to ride out downturns. With a reserve, you won’t have to decide whether to sell or not: you don’t need the money today.
– Weather financial storms. Is the muffler dragging behind your car? It’s covered! Did your dishwasher break down? You can fix it. Sure, you’ll have to slow your investing plan for a bit to rebuild the reserve, but you won’t be sweating the small personal finance stuff in life anymore.
In short, the reserve is the lynchpin of your personal finance plan. Doesn’t that fire you up?
Whether you’re excited or not, saving toward a reserve is a painful part of personal finance. That’s why gurus such as Dave Ramsey set the bar lower, like $1,000. Once you can weather the small storms, then you can focus on bigger fish.
At some point, you’ll need to adequately fund the reserve. There’s good news here. A six month cash reserve isn’t as large as you think it is.
First, people focus on three to six months of income, not expenses, when it should be the other way around. You don’t need six months worth of income. Your gross income from a job includes:
– federal taxes
– FICA taxes
– state taxes (in many places)
– insurance deductions (you’ll need to keep insurances in place, but the cost of workplace life or disability insurance will be removed). Unfortunately, you may have to self-purchase health insurance.
In a pinch, you don’t need to cover many of these costs. Instead, you’ll need only the basics: groceries, gasoline, clothing costs, utilities, and mortgage or rent payments. Add in any other debt payments you’ll have, and that’s your emergency fund amount.
This is a much, much smaller number than you may have realized.
Everyone wants to get their personal finance plan moving in the right direction. Building the foundation of your plan isn’t nearly as fun as what comes after. By focusing on the right number, you’ll have it built more quickly than you first imagined and be on your way to more entertaining goals.