(Guest Post by Joseph)
There are approximately 31 million American’s without a job right now. There are probably at least that many people who have taken a pay cut or a reduction in benefits which served to lower their overall cash flow.
Times are tough right now; I don’t need to tell anyone that (except maybe Apple – apparently they didn’t get the memo). The point is that if you were to lose a source of income and were unable to find employment right away how would you survive?
Or what would you do if you lost 10% of your pay, found yourself living paycheck to paycheck and the transmission busted on your car?
This is exactly the kind of situation you don’t want to find yourself in, because let’s face it, being broke isn’t sexy. Being prepared for emergencies like this is, however.
You need an emergency fund!
You’ve heard it before and you’re going to hear it again. You need to have an emergency fund set aside that you never touch except in absolute emergencies. I’m talking about being laid off or paying for an unexpected life-saving surgery. Something drastic. If it’s not drastic then don’t touch it. Seriously. Financial planners always talk about setting aside money for an emergency fund and predictably most people respond in kind with a comment such as, “I already live paycheck to paycheck, how am I supposed to save for emergencies when I don’t have any money left at the end of the month?”
I’d be willing to bet that 90% of those people could survive if they set up an automatic deposit into an emergency fund. Most people don’t realize how much they spend every month on “discretionary items.” If you think you can’t afford to set up an emergency fund let me tell you that you can’t afford not to set up an emergency fund. It might help if you were to track your money for a few months, I guarantee after you do this you’ll find something that you can do without. Now that you’re convinced let’s move on to the next step!
Make it automatic or else it’ll never happen.
Let’s face it, there are a lot of frugal types out there, but the majority of us don’t have the dedication or the willpower needed to regularly transfer money out of our checking accounts into an emergency fund. That’s where using an automatic savings plan can help. First you need to open a savings account to put your new emergency fund in. Might I recommend ING Direct or another online savings bank that offers a good rate and has a strong reputation? Now that you have an account open to transfer the money to, update your direct deposit so you transfer a portion of your paycheck every single payday into your new emergency fund. By doing the direct deposit you’ll never have a chance to spend the money because you’ll never see it.
How much do you need to save?
Most financial planners recommend between 3 to 6 months worth of living expenses, although some will recommend as much as a whole year. Let’s start small shall we? You need a win to boost your confidence in this new endeavor so I want you to save one month’s worth of expenses (see if you can save this over a three month period). As soon as you have your month’s worth of expenses in your new emergency fund you’ll feel great and it’ll be a lot easier to swallow the drop in your disposable income every month (not to mention you won’t even notice it’s missing anymore after a few months of this). Just leave that direct deposit the way you’ve got it set up now, and before you know it you’ll have six months worth of expenses stashed away for a brutally rainy day (that with any luck will never come).
Let’s take it one step further: You need an “oh-biscuits” fund!
I’m not talking about the edible kind of biscuits either. According to an article I read the other day most American’s couldn’t come up with $2,000 if they needed to. You don’t want to be in this situation. Yeah, you’ve got your emergency fund, but I was serious when I said you can not — NAY, WILL NOT — touch that emergency fund unless something truly drastic happens. So what do you do? You take the same principle that you learned about automating your emergency fund and set up an oh-shit fund.
This fund is exactly what it sounds like it’s for. If something happens that would normally make you swear, you can use the money you have in this savings account. Fix your car if it breaks down. Fix your air conditioning if it breaks down. Pay for a speeding ticket because once again you were driving way too fast down the highway. Stuff happens and rather than putting the cost of “mini-emergencies” on a credit card it’s a great idea to have a savings account like this established.
After you have successfully saved an emergency fund with six months living expenses in it and a “crap happens” fund you’ll be prepared for just about anything life can throw at you (knock on wood). You’ll feel better about yourself, have less stress worrying about what would happen if you lost your job or your pay was cut, and best of all you’ll be able to take the same automatic savings principles you’ve learned to begin to save up for some really neat stuff and say goodbye to credit cards! I told you being prepared for emergencies was sexy!
How are you doing?
Do you have an emergency fund set up? Are you automating your savings? If you do have an emergency fund how many months worth of expenses do you have saved? Have you applied what you learned when establishing an emergency fund to establish an oh-crap fund? Answer these questions in your comments below!
Joseph has been blogging about personal finance since 2008. His favorite topics are getting out of debt, investing, building wealth and automating everything. You should check out his personal finance blog, Debit versus Credit, and follow him on twitter.
(Photo by Calsidyrose)