Day 15: Building an Emergency Fund
When you get rolling under the plan you’ve developed, you’ll discover that (almost always) you’ll come in under budget for the month if you stick to your guns on the nonessential spending. This is a good thing, of course, as it means that you’re being financially responsible.
So what do I do with that excess? Obviously, it’s not a big help if your checking account doesn’t earn any interest and the balance just builds up over time, as it makes it much easier to simply spend it on unnecessary things. Instead, you should move it somewhere where it’s accessible, it earns a little bit, and it’s out of sight and out of mind until you need it. Here’s the game plan.
First, don’t give into temptation and spend it – yet. Although it might seem that this money is a “reward” for being fiscally responsible, it’s actually just a result of the flexible budget you made. The flexibility actually has a purpose: protecting you from the unforeseen events that can happen in the future.
Second, get a high-interest savings account in which to put the money. Why get another account? Several separate accounts make it easy to partition your money and keep money for different purposes separate from each other. This money has a very specific purpose, so we’ll keep it separate.
Now, at the end of each month when you have extra money left over from your budget, just deposit it into this new account. This account will serve as your emergency fund. Every once in a while, life will deal you a hand that is very difficult to play within the constraints of your monthly budget: a car breakdown, medical needs, or so forth. This fund will make it possible to just roll through those emergencies without breaking a sweat – just go withdraw the money you need to cover the emergency and it’s taken care of.
How big should this emergency fund get?
You should let your emergency fund continue to grow with budget leftovers until you have six months worth of take-home salary in it. After that, you have some options: I’d recommend paying off more debt with your budget leftovers at that point.
Remember, this is not an account for big-ticket purchases!
If you’re tempted to use it to buy an LCD television, you should instead reevaluate what your goals are and perhaps change one of those if you feel that a big screen television is more in line with your values. Leave this money alone; some day, you will be incredibly glad you did (like when your son comes home with a dented-up car, for example).
Tomorrow, we’ll begin looking through your expenses for places to trim out more fat without altering your lifestyle.
Ready? Let’s continue on to the next day.