What do every personal finance blogger, acclaimed Wall Street author and millionaire have in common?
A fancy car? Maybe. Little or no debt? Perhaps. An emergency fund? You’ve guessed it!
Emergency funds are the first real step to financial freedom. They represent a security blanket that many of us cannot do without. Money problems keeping you up at night? An emergency fund allows you to rest easy. It’s basically your insurance against the unexpected.
So what is this best kept secret of the rich?
An emergency fund is simply a pile of money that is saved up to be accessed in the case of a real emergency. There are three key features of an emergency fund. The first is that they should only be used in a real emergency. Things like a car accident, a broken pair of glasses or having to pay for your cat’s vet bill all qualify. At the end of the day it is up to you to be honest with yourself and decide whether a certain situation qualifies as an emergency.
The second feature of an emergency fund is that they usually should have at least 3 months’ worth of expenses in them. Some argue that they should include at least 6 months – to which I say you’d be better of investing half, but that is just my opinion. The reason why you need such a big sum saved is that you are saving for the unexpected. You don’t know what is going to happen in the future and sometimes you need to plan for the worst case scenario, that is: losing you main stream of income. For most people, that translates to losing their job. Having three months of expenses saved up ensures that if something of that scale does happen, you have a bit of wiggle room to breathe and get back on your feet.
The third and final feature of an emergency fund is that they are liquid. That means that if you get into a car accident today and needed an emergency hip replacement tomorrow, you should be able to go into your emergency fund right now and pay the insurance excess. An emergency fund should be easy to access and could be kept either in a separate bank account or in cash. It shouldn’t however be so easy to get to that you are tempted to dip into it when you really shouldn’t, which is why I recommend that you stash it somewhere out of sight.
This is all well and great, but why do I need one, you ask?
Well my friends, this is where things get a bit grim. The reality is that when asked, the average American doesn’t even have $1000 in savings for an emergency. Things only get worse when we get to millennials, out of which the majority have less than $1000 and 31% have absolutely nothing at all. I used to be one of those millennials myself and let me tell you, the struggle is real.
I don’t want to be the majority and I don’t want you to be majority either. I want both of us to live long, happy lives with financial security and the power to do over money as we wish, not the other way around. The first true step to financial freedom and getting yourself on the right path is starting an emergency fund. When I lost my job, broke both my partner’s and I’s phones and had a major bathroom leak (all in the same week mind you), my emergency fund was there to save me. It can save you too. So why not start today?
Let me know in the comments below the one time you could’ve really used an emergency fund!
Remember, being broke is temporary. Being rich is a journey.