Everyone needs an emergency fund
Build yours using this short guide
Now, more than ever, building an emergency fund is a relevant topic. It’s April 2020, Covid-19 lockdown is in full effect in the US and 6.6m Americans have just filed for unemployment benefits.
For those lucky enough to remain gainfully employed during this period of uncertainty, it may be a good time to revisit their savings. A lot more of us are going to be needing a fallback in the event that this period sustains for the long-term. For those unfortunately impacted already — as some of my family members have been — I hope this article can help you when you get back on your feet.
The good news is that many of us will be receiving some help from Uncle Sam: up to $1200 per person. That’s a great place to start building your emergency fund from.
Set your goal
How will you know when you have enough money saved in your emergency fund? You need to set a goal.
I’m definitely not the first person to write about building an emergency fund. If you google ‘emergency fund’, you’re going to find tons of posts telling you how. What many of these writers miss is that while most readers have good intentions, executing over sustained periods with discipline is hard and life gets in the way.
That’s why I recommend starting small with your goal, beginning with monthly increments, rather than setting lofty 6 to 8-month emergency fund targets. Yes, you should strive to get there, but you need to have a 1-month emergency fund first. Then 2, then 3, etc. Starting with a 1-month goal still encourages you to set money aside, without being seemingly insurmountable. This 1-month emergency fund goal should be equal to your average 1-month expenses.
A quick, and dirty way to calculate your 1-month expenses: look at the withdrawals line item in the summary section on your monthly bank statement for your primary checking account, and take the average of this number over the last 6–12 months. If you have multiple accounts — checking or otherwise — that you or your family pull from each month, add those in over the same time period to find your 1-month number.
The second thing you’ll need to do after identifying the amount is to determine the time period in which you want to achieve that goal. Fixing the time frame you want to achieve your goal within and then determining the amount you need to put aside each period will force you to make sacrifices on where you’re spending, which will better enable you to achieve your goal.
A quick, and dirty way to calculate your 1-month expenses: look at the withdrawals line item in the summary section on your monthly bank statement for your primary checking account, and take the average of this number over the last 6–12 months.
Identify where your emergency fund will come from
Once you’ve determined your 1-month goal, start identifying where your emergency fund will come from by looking at how much excess you have in income each month (you likely know this right away, but if you don’t, you can use the same monthly statement tip from above, this time looking at the deposits line item, and comparing that with your avg monthly expenses).
If you do the above and your income is in excess of your monthly expenses, figure out how much of that you would like to put aside into your rainy day fund. The more you put aside, the faster you can meet your goal.
If you do the above and your income is below that of your monthly expenses, you’re currently running at a deficit. You’ll need to find ways to cut down on your expenses in order to build your emergency fund, otherwise, you’ll just continue to eat into it. There are plenty of great articles on the web regarding how to do this, but here are a few ideas:
- Cut your utility bills with a programmable thermostat.
- Try eating out less by using a meal delivery service like Hello Fresh. (And learn a bit of cooking while you’re at it!)
- Review your insurance policies and get quotes to switch. Things are always changing here, so this is a good habit regardless.
- Streamline your subscription services. Amazon, Netflix, Hulu, and HBO tend to add up. Pick your favorite and cut the others.
- Buy a cold brew pitcher to make your morning iced coffee at home.
Determine where to store your emergency fund
You have many options here, and what you choose will depend on your preferences.
Option 1: Your existing primary savings account.
- Pros: Convenient! Easy to move money into and no new accounts to open.
- Cons: Easy to move money out of and your funds are losing purchasing power over time (US inflation in 2019 was 2.30%). If not a high-yield account, likely not paying much in the way of interest at all.
- Who is it for? The saver that needs to be able to access their funds fast.
- Examples: Bank of America, Wells Fargo, Chase
Option 2: A secondary savings account that pays high yield interest.
- Pros: Pays high yield interest on your deposits up to 1.75% APY (as of April 2020). Ability to put emergency fund somewhere you don’t see it every day, while still being easily accessible.
- Cons: Better rates can be had elsewhere.
- Who is it for? The conservative saver that wants to keep their emergency fund out of sight.
- Examples: Marcus, CIT Bank
Option 3: Money market account
- Pros: A combination of high yield savings account and checking account — a good mix of features with typically higher interest rates than a checking account and a little more flexibility than a savings account.
- Cons: Easier access to funds means more temptation to spend from the account.
- Who is it for? The saver who needs to have access to their emergency fund on the go.
- Examples: Sallie Mae, CIT Bank
Option 4: Certificate of Deposit
- Pros: Fixed rates higher than traditional high yield savings accounts.
- Cons: Funds traditionally have to be locked up for certain periods in order to earn the stated interest rate. Early withdrawal penalties may apply. Harder to contribute to in short, recurring instances.
- Who is it for? The saver who has an emergency fund already started, wants the highest rate and doesn’t expect to access their emergency fund any time soon.
- Examples: Marcus, BMO Harris
Option 5: A high yield savings account alternative
- Pros: Significantly higher yield than the above options, with low correlation to US Federal Reserve interest rate movements. Ability to put emergency fund somewhere you don’t see it every day, with built-in savings features. Great user experience.
- Cons: Slimmed-down feature sets compared to traditional banking products. FDIC insurance availability varies.
- Who is it for? The aggressive saver that likes new technology and wants to earn the best interest rate.
- Examples: Linus, Donut
[Disclosure: I am Co-Founder of Linus, and you’re reading this in the Linus Blog.]
Execute
Step 1: Schedule your deposits
Plan your emergency fund contributions around your income. Get paid weekly? Make weekly deposits. Get paid monthly? Make monthly deposits. Schedule future dated payments using your bank’s app or schedule recurring calendar reminders to grab your attention when it’s time to make your contribution.
Step 2: Automate it with recurring transfers, if possible.
Automating your contributions is proven to help savers meet their goals. If your bank or app offers this, it’s highly recommended to use to meet your goal.
Step 3: Snowball excess funds
Getting a tax return? Getting an extra $1200 as part of the CARES stimulus? If your financial situation allows, act like you never got it and send it immediately to your emergency fund.
Miss a payment or two? That’s ok. Don’t get yourself down. What’s key is that you don’t give up.
Celebrate milestones along the way
Every deposit is progress towards your goal, so each deposit is a milestone. Take some time to appreciate your progress towards financial health, even if it’s small. Personally, I like to tell my dogs and watch them get excited (who cares if they don’t actually know what I’m talking about).
Once you hit your 1-month goal, keep going. Set your 2-month goal, and increase your savings amount if you find that hitting your one month goal was easy.
You’re on your way to financial security.
