On a recent Moneywise Guys radio show, we discussed the importance of setting up an emergency fund. A caller expressed frustration at needing to have six months' worth of paychecks saved up. The caller admitted to giving up on the idea of an emergency fund because it just seemed impossible to save that much.
Although often overlooked, preparing for an emergency or job loss is an important part of an overall financial plan. Like this caller, you might be overwhelmed at the idea of saving so much and may want to give up before you even start. Don't give up. Instead, consider the fact that you may already be much closer than you think. As with most financial goals, creating an emergency fund starts with small baby steps.
If you currently have nothing in an emergency fund, start with setting enough money aside to cover one week worth of expenses. Make it a habit to set aside money with each paycheck and you will see this emergency fund grow each month. Even better, have your bank automatically transfer a portion of each paycheck to a savings account used for this purpose.
Determine emergency fund amount needed:
Rather than simply deciding the amount you will need by multiplying your paycheck by three to six months, initially, determine the amount needed for your emergency fund based on the amount of necessary expenses you will need to pay over a period of time. For instance, if your current monthly expenses are $2,000 but you know you could cancel your cable ($100), lawn service ($50), gym membership ($50), and pool cleaning service ($100), you are left with the need to cover only $1,700 of expenses.
Remember, the intended purpose of the emergency fund is to cover critical items like paying important bills rather than simply replacing lost paychecks. As your emergency fund grows, you can increase your goal until you actually can cover three to six months of paychecks and not just expenses.
Consider other factors:
You should also take into consideration a variety of other factors that can impact how much you need to save, including the willingness of your creditors to put debt payments on hold for a certain period of time, large ticket items you would be willing and able to sell, and any unemployment or other benefits that may be available to fill a portion of the gap between your expenses and emergency fund.
Securing a short-term disability insurance policy can also significantly reduce the amount of emergency funds you'll need. By paying a small monthly premium when you're healthy, you protect you and your family financially if you were to become disabled.
As you get your initial emergency fund started, continue to add to it to create more of a cushion to ease the financial hardship should you need to access it. Just don't get overwhelmed and give up before you even start. If you start with small baby steps and make it a habit to set money aside for this fund, you will soon have the amount you need and you'll find that reaching this goal was easier than you thought.
Paul Anderson is an investment advisor and partner at Moneywise Wealth Management. He is also a host of the Moneywise Guys radio program on KERN 1180 weekdays 10 a.m. to noon. His email is Paul@moneywiseguys.com and website is www.MoneywiseGuys.com. Advisory Services offered through: SCF Investment Advisors, Inc. Corporate Office: 155 E. Shaw Ave. #102 Fresno, CA. 93710 800-955-2517. These are Anderson's opinions, not necessarily those of The Californian or SCF.