This is the final post in a three part series on reducing the stress of personal finance. Each post details a simple technique to reduce financial headaches. Previous posts discussed using a personal escrow account to help smooth out yearly or irregular payments and using the envelope method to smooth out monthly spending. This post focuses on unexpected spending.
Emergency Fund
Unexpected things happen. That’s just life. A well stocked emergency fund can make those events easier to handle from a financial perspective. The sting of a broken down car, lost job, or last minute travel for a family crisis will still be there, but paying for them will not add to the stress of the situation.
An emergency fund is exactly what it sounds like. Money set aside in a separate account to deal with emergencies, real emergencies. When an emergency happens, you’ll be prepared and can say “I got this“.
When an emergency does occur, don’t feel bad about using the money in the fund. This is a hard one for me to accept because I don’t like seeing money leave my emergency fund. However, this is exactly why you save the money. Spending from your emergency fund is much better than charging to a credit card and then having to pay off the debt.
As usual, money topics relate to bikes, right? And it’s not for saving money to buy that new bike you want. Suppose you have been saving (in a separate account) for that dream bike trip later in the year, but then your car has some major issues and your fridge dies. Here is where Mr. Emergency Fund steps in to pay for those unexpected expenses instead of using the money you had saved for your dream trip. In the end, the emergencies are handled, you are still riding that dream trip, and you have no additional debt. Success.
How Much To Save?
This is a very interesting question. Experts suggest anywhere from $1,000 to 6 months of living expenses. My suggestion is to aim for that magic $1000 in savings first, just like Dave Ramsey suggests in his baby step 1. That amount will cover basic emergencies, but maybe not a job loss or multiple emergencies back to back.
Don’t stop saving after reaching the $1,000 milestone. Setup an automatic transfer each month to keep building up the fund. The final goal should be a fund that can cover multiple months of living expenses and multiple emergencies back to back. Some people make their end goal 6 months of expenses while others may aim for a nice even number like $5,000 or $10,000. To choose your goal, use Caleb Wojcik’s advice of picking what makes you comfortable. Everyone is different, but the key is saving to be prepared.
When setting up your emergency fund, keep it in a separate savings account so that it can be easily accessed. Some people even setup the account at a separate bank to resist the temptation of using the money for non-emergencies. Finally, don’t worry too much about the interest rate of the savings, especially with the puny rates accounts are earning these days. Your focus is on having the money available for emergencies, not to earn and extra few dollars of interest.
Less Financial Stress
And that concludes this series on reducing your financial stress points. Whether it’s envelopes for monthly spending, a personal escrow for irregular yearly expenses, or an emergency fund for unexpected expenses, the key is always “spend less than you make”. With that commitment and the three techniques from this series, hopefully your financial stress will be greatly reduced.