On the path to financial independence, an emergency fund will be one of the best friends you will ever have.
I first heard the phrase “emergency fund” in 2009 when I was reading The Automatic Millionaire.
Back then, I was still neck-deep in the financial quagmire I’d thrown myself in during the recession.
My subsequent launching of an emergency fund has provided me amazing peace of mind in the last 10 years.
Because of my emergency fund, I have been ready for any surprises life has thrown at me since 2010.
My emergency fund is also the reason I didn’t feel any sort of panic when my offline income started taking a hit at the start of the pandemic.
It is one of the best things I ever did for myself and it didn’t cost me that much.
So what’s an emergency fund? Why do you need one? Why is an emergency fund the best investment in peace of mind you’ll ever make?
And how do you determine what should be in your emergency fund? I’ll be covering all of this and more in this article plus an offer at the end.
What Exactly is An Emergency Fund?
An emergency fund is money you tap into when you have emergency expenses like car repairs, house repairs, or something else.
It’s money you can spend without feeling stressed out because that’s exactly what the money is designated for.
- Car needs new breaks?
- Washing machine part replacements needed?
- Extra medical expenses?
- Laid off for a bit and need to pay rent?
- It’s time to get on a space ship and leave earth with the astronauts?
With an emergency fund, the answer to all of the above is, “Yes, yes. No problem. I got it covered.”
That is the peace of mind having an emergency fund buys you.
Even if you are the CEO of the largest corporation on earth, you still need an emergency fund. Why?
Nobody is indispensable and anyone can get fired. The more extravagant your lifestyle is, the more of a cushion you need for a sudden loss of regular income.
How Much Money Should You Have in Your Emergency Fund?
The general rule is 3 months of your overall monthly expenses. As I like my contingency plans to have their own contingency plans, I opted for 6 months.
When I’d paid off debt fully, got my investment and retirement accounts going, I upped my emergency fund to 12 months.
However, in the beginning, I had to start small and just took little steps to get to at least one month.
$50 here, $70 there, $100 or more when possible but never less than $50 every month, no matter what.
I needed that comfort of knowing if something happened to my car, I could fix it without putting the bill on my credit card.
Too much money?
How about $10? $10 every week is $480 by the end of the year. Start small but don’t take your eyes off the big picture.
3 months’ expenses saved sounds like an insane target when you’re in debt but trust me, this is more important than paying off that debt.
Right now, my emergency fund is 12 months because I’m self-employed. With an irregular income, I need an even bigger cushion.
Having this cushion helps me sleep well at night and wake up when I like. If sleeping were an Olympic sport, I’d have as many medals as Michael Phelps.
How Long Does It Take to Put Together an Emergency Fund?
When I started my emergency fund, I knew how much had to be in it but it was impossible to accumulate that much so quickly because I was in so much debt.
What did I do?
After I’d committed to getting a little bit of money in the emergency fund every month, I started working a few side hustles.
Every penny earned from the side hustles went into the emergency fund. Every. Penny.
Where Should I Put My Emergency Fund?
Your emergency fund should be in a place that generates some income and keeps it out of your reach but not so far that you can’t quickly liquidate in case of an emergency.
I put mine in a mutual funds account initially but when I moved to Canada, I started putting some if it in a high-interest savings account.
I also opened an investment account with Questrade and started stacking the max every year in my TFSA account.
Whichever place you choose to stash your emergency fund depends on financial options available in your country.
But whatever you do – never put it somewhere you can easily access it. Make it work for you until you need it.
There are arguments that having so much money sitting in a savings account is a waste but remember this money is for emergencies only. It’s financial insurance.
You shouldn’t be playing gambling games with it and trying to triple it within a few months. Let it do what it does in a savings account.
How to Start an Emergency Fund
1. Calculate Living Expenses
Tally your essential living expenses and figure out how much you spend every month.
I said essential expenses i.e. if you don’t spend that money, you’ll be homeless, go hungry, run out of air to breathe. Coffee is not an essential expense.
For example, my essential expenses include:-
- Rent & utilities
- Transportation – bus pass, car payments, etc.
- Phone bill
- Health insurance
This is what essential expenses for most people would look like.
If you’re in debt and have expenses you must pay every month, that goes on the essential list as well.
2. Shear Down Non-essentials
This is where frivolities like coffee and eating out need to be shown the door because that extra money needs to go into the emergency fund.
You have to go full Darth Vader on your non-essential expenses. You can loosen up a little later but not right now.
3. Get Your Hustle On
Are you into crafts and other DIY items? Consider starting an Etsy Store.
Don’t have enough time to carve out for an additional career?
You can engage in activities like focus groups, completing surveys, and mystery shopping in the evenings and weekends.
I will create individual posts later on around getting your side hustle on. Check out more side hustle ideas at What is a Good Side Hustle?.
And don’t forget. Every penny from the side hustle (s) goes into the emergency fund.
As I said in the beginning, on the journey to financial independence, an emergency fund will be one of the best investments you will ever make in peace of mind.
If you don’t have one, start today.
Recommended resource – struggling to get it all together financially, Easy Guide to Money Management: Small Steps for a Huge Difference could in useful.
The resource includes financial worksheets, a starter budget template, and a bonus offer worth $30. It’s rated 5 out of 5 stars. Grab it for free HERE.