I speak a lot about my father’s advice and my mother’s examples of money management, but “pay yourself first” is the foremost piece of financial advice that stuck at a young age. It was the most consistent piece of advice my father gave me and my siblings from my childhood to adult life, pay yourself first.
My father sat me down one day when I was nine years old and said “The best debt is no debt. But if you find yourself in debt, the pay yourself rule still stands. Your creditors are not going to pay your rent or your medical bills if you lose your job. I don’t care how much you owe, and you shouldn’t owe anything, you pay yourself first so you can have a nice cushion to fall back on in case of the unexpected”. This was the beginning of many lessons on managing money and staying out of debt. I think he was planting the seed of financial empowerment so that once we moved out we would not be moving back! It worked, for the most part.
My father advised us to take ten percent of all income and put it away. He went so far as to say if you find a quarter on the ground, take ten percent of that. He drilled this one concept into us so often that to this day, at 59 years of age if I find a quarter or penny, I put it in a piggy bank or in a special pocket to be deposited later. Ten percent of all income means raises, income tax checks, inheritance, payment from a sale, income from a second job, take ten percent of all income and put it in your emergency fund. Once you start it, especially if you have it automatically deposited, saving becomes a habit. You will be amazed at the end of the year how much money you have amassed and how easy it is to save.
How the Emergency Fund Works
An emergency fund is used when you have a life changing emergency I don’t mean the new iPhone 800 is coming out or I want some new clothes type of emergency. Emergencies generally involve loss of health, loss of income, loss of a spouse or loss of transportation to get to work. This account is your get out of jail free card; it is the key to beginning a life of financial independence (FI) so don’t screw around with it.
Figuring out how much you need to live on each month is crucial, it’s a fine balancing act. Before you begin building your emergency fund you need to have a clear picture of your monthly expenses. Here is a sample budget sheet from consumer.gov.
Using the budget sheet, assess how much money you are bringing in, your income, and how much you are giving out, your expenses. In a perfect world, your income should be greater than your expenses. In figuring out your budget, when you begin to list who you owe and how much you owe, the first thing you should write is your name, then an amount that is ten percent (or whatever you are capable of saving) of your income. That ten percent is your emergency fund. You should always be at the top of the list of people you owe. You always come first.
A budget and a goal is the backbone of your savings plan. Add up the expenses listed on your budget. This is what you need to have on a monthly basis to live. This amount is minus the cost of movies, dining out, subscriptions and other frivolous items. If you lose your job, all of those things should be put on hold until you are bringing in money. You can find fun activities that are free. Take the total amount of expenses and multiply it times 3, 6 or 12 (depending on how many months you want to save). This is the amount you need to have in an emergency fund in case you become ill, can’t work, lose your job or a host of other life-changing events that can negatively impact your income. I think three months worth of living expenses should be your minimum goal but you know your finances best so make decisions based on what is comfortable for you. But let’s be realistic, if you lose your job in today’s economic and employment environment it could take more than three months to find a job. My father always said you should have six months to a year’s worth of living expenses in your emergency fund. For many that may not seem doable. But anything is doable over time. It is more doable than you think. Think minimalism. More on that in later posts.
Where do I put the money for my emergency fund?
In a perfect world it would be automatically deposited into a high yield savings account that is liquid, readily available. Let’s face it a savings account is not where you grow your money. It’s where you put your emergency fund money so that you will have it exactly when you need it. It should be in a federally insured bank account. The immediate nature of most emergencies require that you have quick and easy access to your money. Anything beyond a savings account will probably cost money to get access, require a waiting period of two or more days and involve a possible loss of money. A savings account is your best bet for emergency funds.
If you are trying to reach a 6 to 12 month emergency fund another option for a higher interest rate is redirect your ten percent (after you have three months in a savings account) to a mutual fund, money market or a short term certificate of deposit. The three month emergency fund stays in the savings account while you build the rest of the emergency fund via mutual fund, money market or certificate of deposit, until you reach your 6 or 12 month goal.
When can I start investing?
You should work on building an emergency fund first and the investment component comes after you have met your emergency fund goal and are out of debt. The discipline it takes to build a 3, 6, or 12 month emergency fund will help you to be more committed in the investment phase of your wealth building plan.
You should not even think about investing until have read enough, questioned enough, researched enough to make informed decisions about where you want to put your hard earned money. You will need to be extremely patient and committed to the process in the investing phase because it takes patience. Investing is not a short-term endeavor. Depending on the market and the investments you choose it may take longer than you might expect to see your money grow. Be patient. While I can’t give you information about how or where to invest, there will be more to come on preparing to invest in future blog posts.
“If you are worried about job security and do not have an adequate emergency fund (ideally eight months’ worth of living expenses stashed away in a federally insured bank or credit union), you need to focus more on saving money than paying down the balance on your credit cards.”
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