Emergency Fund: The One Thing That Will Make or Break Your Financial Journey
Reaching financial independence is a huge challenge. It can take years of grinding away, making small amounts of progress at a time. The good news is that these tiny steps add up to big leaps over a long period of time. Despite this progress, one simple slip up can cost you months or even years of progress. Some of these setbacks will be entirely your fault like giving into peer pressure and buying that brand new convertible to rival your neighbor’s new ride. Some will be out of your control like an unexpected illness or natural disaster.
After a while, you might start to feel a bit like Sisyphus from Greek mythology who was sentenced to roll a massive boulder up a mountain for eternity. Despite making slow and steady progress, he loses his grip every time he nears the peak of the mountain. As a result the boulder rolls back down the mountain and Sisyphus is forced to start all over.
Fortunately, you don’t have to be like Sisyphus. Financially, having an emergency fund set aside for unexpected events can be a life saver. Without an emergency fund, you’re forced to start your financial journey from square one over and over and over. I believe this is the single most critical point of failure for people who are trying to become financially healthy. Setbacks can be extremely frustrating. Experience enough of them and you’re more likely to throw in the towel. There is a reason why the majority of financial experts emphasize building an emergency fund right off the bat. Having an emergency fund to cover most (if not all) of the financial emergencies you could encounter is what keeps you moving forward without feeling like repeatedly punched in the face by Mike Tyson.
Here’s the challenge. Building an emergency fund is much easier said than done. A lot of people never make it past this very important step. But, your not like “a lot of people". Let’s look at how much you actually need and how to build up an emergency fund as quickly as possible so you can really make a dent in your financial goals.
How Much Should You Set Aside in Your Emergency Fund?
There is a wide range of opinions on how much people need in an emergency fund. Some financial experts like Dave Ramsey recommend starting with as little as $1,000 (although he does circle back and recommend more at a later point). Others say that you need enough to cover a minimum of 3 to 6 months of living expenses. There are even some financial coaches that are on the extreme end of the spectrum by claiming the only way to be completely protected is to have enough to cover a full year of living expenses.
I’m not a huge fan of cookie-cutter financial advice. While I do find that the 3 to 6 month target is the sweet spot for most people, there are pros and cons to having smaller or larger emergency funds. If you set aside too little, you’ll fall victim to the same stress and setbacks as not having an emergency fund at all. What good is a $500 emergency fund when you’re staring down a $1,500 car repair? So, you might assume that I’m advocating to stockpile as much as possible. Not exactly. The downside to having too large of an emergency fund is that cash (even sitting in a low yield savings account) loses value over time due to inflation. You want to minimize this erosion of your net worth. In addition, the best way to grow your net worth is to put it to work in investments like real estate, stocks, or bonds. Sitting too much cash on the sidelines means you are missing out on the potential for long-term growth.
Here are some things to consider when deciding how much you need in an emergency fund:
Does your family have more than one income? If so, you might have a lower risk of both of you being out of work at the same time.
Are there any things in your budget that you could immediately cut if you run into financial trouble? For example, if you budget $500 a month for eating out, you could easily pause that activity so you might not need to have emergency funding to cover that expense. Personally, I only consider non-negotiable items like your mortgage, utilities, groceries, car payments, etc.
Do you work in stable industries? People who work in volatile industries should have more stocked away in their emergency fund. My wife is a tax accountant. The probability of people not needing her services is slim to none, so I would consider this a stable job.
Do you have any current risks? For example, is the roof on your house 20 years old and at risk of leaking this winter? Or do you drive a beater car that has a slipping transmission that will need a repair any day now?
Your goal is to use these questions to figure out what the worst possible scenario that you need to be prepared for. For my wife and I, we’ve found that having more than a 2 month emergency fund is overkill since we both have very stable careers, side hustles for supplemental income, and also have a number of assets that could be quickly liquidated if we run into trouble. Again, this will totally depend on your personal situation.
Speed is Critical When Building an Emergency Fund
Most people understand the importance and benefit of having an emergency fund. Despite this, building an emergency fund is probably the single biggest failure point for people on their financial independence journey. It’s not because they don’t try to build an emergency fund — It’s because they move too slowly. Unfortunately, time isn’t on your side. Emergencies and unexpected are bound to come up if you wait long enough.
Let’s look at an example. Let’s say you need to save $10,000 to cover three months of expenses. You’ve established a monthly budget and expect to have $300 left over each month to put in your savings account. At this pace, you can expect to have a fully-stocked emergency fund in just under three years. That’s a really long time in the world of personal finance. It’s extremely unlikely that you will avoid unexpected costs that require you to dip into your emergency fund for three years. Hell, we’re lucky if we can go a month without some mini-crisis that requires money beyond our budget such as trip to urgent care, a sick pet, a flat tire, or an unexpected trip to attend a relative’s funeral in another state. What happens if you get hit with an unexpected home repair for $2,000 and you’ve only stocked away $1,200 in your emergency fund. Not only are you back to $0, but you might have to take on debt to cover the remaining balance. In other words, you’re fucked.
For this reason, you have to move as quickly as possible to establish a solid emergency fund. You probably won’t be able to make a three month emergency fund magically appear out of thin air. However, the faster you move in the beginning and the larger the emergency fund, the less likely you are to let that boulder roll back down the mountain. If you’re looking to quickly stock up your emergency fund, here are some simple things you can do:
Sell an Extra Vehicle — About a quarter of all households in the US have three or more vehicles. If you have an extra car or truck around, you might consider selling it to get a sizable boost to your emergency fund (if you are lucky, cover the whole amount needed). You can always buy the extra vehicle at a latter date when your finances are in better shape. Also, this vehicle doesn’t have to have wheels. You can also sell a boat, jet ski, snowmobile, etc.
Do You Even Lift, Bro? — Let’s face it. A lot of people have gym equipment that they spend hundreds of dollars on but it sits in the corner collecting dust. Go around your house and gather up all the big ticket items that you never (or rarely use) like treadmills, camping and outdoors gear, electronics, video game consoles, power tools, old baby stuff (cribs, strollers, car seats), etc. Selling a bunch of unused items in a garage sale or on Facebook Marketplace is a great way to quickly get a few hundred (or even a few thousand dollars).
Get a Second Job or Side Hustle — You may consider getting a part time job for a short period with the goal of putting 100% of your pay into your emergency fund. The nice thing about this is that it’s short-term. You can simply quit when you reach your goal (or keep going to give your finances an even bigger boost). Side hustles can include babysitting, pet sitting, walking dogs, washing cars, or even writing online.
Give Your Budget Another Review — Even if you think you have a strict budget, it never hurts to take another look. Any opportunities to reduce your expenses is extra money that you can put toward your emergency fund. For example, have you renegotiated your car insurance rates lately? Do you really need five different streaming services each month?
If you’ve never had a fully-funded emergency fund, it’s difficult to describe the sense of peace and security of knowing that you can weather any storm the universe throws at you. Trust me, it will be totally worth the hard work. You’ll be amazed at not only how much better you feel, but also the massive amount of progress you can make financially when you experience bumps on the road to financial independence.
