Disclaimer: The statements made in this post are the opinion of the author. They should not be viewed as financial advice. Please consult with a financial specialist before making any financial decisions.
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Most people don’t seem to worry about financial freedom (more on this idea later) because they can’t even get to a place of financial security–although people may dream of winning the lottery and lying on the beach. So before you can take the steps to become financially free, you need to take steps to be financially secure.
The first thing to prioritize then is building up an emergency fund that you are comfortable with. The basic idea behind an emergency fund is having money set aside that you touch for nothing else other than emergencies. When you have to use your emergency fund, your first priority before paying down extra debt, saving or investing is to pay back what you’ve used. I’ve even heard some people recommend paying your emergency fund back plus interest.
Why is this important?
First, most Americans (and I would assume most everybody) don’t have sufficient funds to cover a $1,000 dollar emergency in their savings. That is why Dave Ramsey, the popular financial coach, says that the first step is to build a $1,000 emergency fund before even paying down debts. He says, “You don’t want to dig a deeper hole while you’re trying to work your way out of debt!” Lack of savings is the main reason people feel insecure in their finances.
Second, having even a small emergency fund gives peace of mind. If someone were to lose their job and they had $50 in their bank account, their finances are immediately at risk of collapsing unless they find another job immediately. If you have $1,000 in your account, you can at least cover expenses for a few weeks, or maybe pay rent/a mortgage for one more month. That gives you some breathing room when searching for more work. The more money you have in your emergency fund, the more secure you feel.
Keys to a Successful Emergency Fund
The most important motto of personal finance is “Personal Finance is Personal”. What that means is that I cannot tell you what your optimal path to financial success is. You need to figure it out for yourself. That is true for an emergency fund. What I can tell you is that $1,000 is not enough, that is just a place to start. Some people feel very secure having just one month of expenses set aside. The most common is 3-6 months. Very conservative people have 9 months to a year of expenses set aside. And I’ve even heard of one couple that have up to 5 years of expenses set aside! (You don’t need that much).
The other important key to remember is that your savings and your emergency fund are actually different. Savings implies money that is being saved to purchase something (a down payment for a house, that trip to Fiji you’ve always dreamed of, or even the four-wheeler you’ve been eyeing). This is money you deliberately set aside to be spent later so you don’t have to go into debt to make a purchase. Your emergency fund cannot be the same as your savings because then you’ll feel guilty for using it for emergencies (like you’re taking away from your Fiji Fund) or you’ll need the emergency money the week after you’ve spent it all on your new four wheeler. So keep them separate. You can keep them separate either in completely different bank accounts or by putting money in different “buckets” in one account; some banks allow you to electronically separate your money into categories that they call buckets, look into that option if it interests you.
Concerns you May Have
Please remember that I am also on this financial journey and I am not perfect. I have been frustrated many times when I’ve heard someone say “Just save money for a substantial emergency fund”. You’re probably thinking, but I don’t have any money leftover! Hopefully, by tracking your spending you are now spending less than you earn and you have identified expenses you can cut. That extra amount is what you would put into your emergency fund (however small that amount is) until you’ve reached your goal of 3, 6 or 9 months, etc. worth of expenses.
If you are still barely squeaking by, then you may want to consider ways to increase your income. I know it is hard upfront, but financial security is just easier with even a few hundred dollars of extra cash each month. Resist the urge to spend your new earnings and build that emergency fund. I’ll write more about increasing your income later, but for now this site is very helpful for generating ideas on ways to earn more income.
You can’t become a financial success and be financially free until you have taken care of financial security. The first priority of being financially secure is building an emergency fund. Start with $1,000, then you can take on some other projects like paying down debt, then build your fund to whatever size makes you most comfortable. The important thing is to start building your fund, no matter how small your contribution is each month.
What benefits have you experienced from having an emergency fund? What are some obstacles you see to building an emergency fund? Tell me about it in the comments below.
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Financial Freedom-Being able to cover all of your expenses each month without having to work. This doesn’t mean you don’t work, and it comes in a variety of ways from investing in stocks to real estate to businesses, etc. Your path to financial freedom is your own.
Financial Security-Being in a position to be able to cover expenses in case of emergencies, such as job loss, major medical event, or accidents. The foundation to financial security is an emergency fund. It is NOT having a secure job which is not in your control. What makes you feel financially secure is up to you.
Emergency Fund-Money set aside to be used in emergencies only. When you use money from your emergency fund you will need to replenish it as soon as you can.