Break Only in Case of Emergency
Emergency Fund
Photo Credit: junce
The neighbors just went out of town and their dog sitter fell through. They called me. I love their dog. I thought it was a favor. They surprised me and they paid me. They paid me well, the fallen through dog sitters rate. I was excited to get the money. I may have even exclaimed “holy crap!” in their faces I was so surprised. Then I thought about my goals and how I could set this aside to buy a condo with a beach view, how I would sleep to the sound of the waves and wake up to walk the beach at sunrise every morning before work. This wasn’t just a treat for watching a dog I already love; it was a nice surprise to help me get just that much closer to this dream.
Then I bought that Kühl jacket that I was eyeing last fall online. Not on sale. Oddly, it cost exactly as much as the check the neighbors wrote me. Yes, they paid me with a check. But I deposited it on my phone – I’m in this century.
That jacket will be great for the cool damp sea breeze. But that’s exactly not the point.
What is an emergency fund? What is a goal fund? What is a sinking fund? (Answer; a Sinking Fund is a topic for another day.) How does anyone save and leave it saved? How do I know when enough is enough? How do I know if I have too much cash? Sure laugh, but there are some people who have this figured out and they are sitting on cash and no dreams. (Refer back to my post on how to dream – aptly named “How to Start Dreaming - Goal Setting 101”).
There are no real rules of thumb because everyone earns differently and has different life circumstances and expense and people that they support. But if there were a few guidelines that could help us they may be:
· 50 30 20
· Keep your fixed living expenses to under 50% (or half as I like to call it) what you bring home after you have paid your taxes. This includes where you live, utilities, basic groceries, education expenses.
· Up to 30% of your after-tax bring home income is a safe-ish amount for the fun bits that make up lifestyle and the fun in life (I really like to look at this as at least 20% up to 30% - not because I am the killer of joy… joy is coming, fret not). This includes dining out, travel, non-human companion animals and their care.
· 20% (or up to 30% if there was less on the lifestyle side) is then available to save. Every month. Every check. Every income. Every time. It’s a formula. It’s simple. It’s math. It’s not emotional. It just is. It isn’t scared. It isn’t scarce. It doesn’t want Kühl jackets, designer hand bags, or shiny things. It just saves and feeds real long-term dreams and feelings of safety and security.
· Of the 50 30 20: In the 50% that includes housing, if half or less of that 50% is your actual rent, mortgage, interest, insurance, tax, association dues, and maintenance – you well feel really comfortable, and your living expenses will not squeeze out your other dreams. That’s the goal. As someone who studies people’s incomes and their lifestyles, yes, I’m aware home prices and rents have gone up. They always have. They may continue to. It’s a guideline, and we can help make life choices that are comfy. Translation. Try to keep housing expenses to 25% or less of what you bring home after your taxes are paid.
· Taxes. Ug. Where do you live? Are you self-employed? Let’s talk. This is serious. Notice all calculations were AFTER this. This isn’t one of those things you save for if there’s money left over. You do this first.
· Savings after you save for taxes. I know the formula is 50 30 20. But it should be:
· Earnings minus 1/3 saved to pay taxes – in it’s own tax account – not used for anything else (roughly 30% in the US (50% in the UK)) = bring home income
· Bring home income minus 20% to saving = Living Expense
· Please notice we have saved before we start spending.
· Living Expense = ½ of your bring home income is for your fixed expenses; what you need to live
· Lifestyle is the remaining money (roughly 20-30%) of your bring home income, this is a number that you can spend on whatever you want every month because you have already paid your taxes and saved!
This, my friends, is the path to enlightenment, freedom, autonomy, and lack of stress.
This process also stops decision fatigue. You do not have to make choices at the check-out counter. Your savings money is safely stowed away, and you know what you have available to spend on lifestyle, and you can spend it guilt free.
So, what are you saving for? Why?
The #1 goal of all whom have taken the CERTIFIED FINANCIAL PLANNER TM exam is to keep their client safe and to make sure their client has AT LEAST one month of their fixed living expenses as a safety cushion. That’s the #1 minimum goal. I prefer one month of fixed and lifestyle expenses, but that’s just me. Then, it expands from there, once a “safety” has been put in place.
Here are more rules of thumb about how much of an Emergency Fund do you want:
· Two people and two incomes: If someone is married or partnered and each person has stable employment with regular pay, having three to six months of fixed living expenses would be acceptable. The thinking is that if one person gets sick, hurt, or loses their job, the other person would likely continue to work, so the demand on the savings account would be less because there would still probably be one income. If both parties lose jobs or are unable to work, then that would be more strain on the emergency savings and harder. If both people work for the same company, three months of an emergency fund may not be enough, if there was ever a chance of both people losing their jobs at the same time.
· Two people and one income, or two people and one of them is self-employed with variable income: In this scenario an emergency fund of six to twelve months is considered fair.
· One person: Six to twelve months of fixed expenses is recommended based on your desire for safety.
· Starting a brand-new business – taking a calculated leap: Please don’t tell me to go jump off a cliff. In this scenario, it would be amazing to have three years of living and business expenses at the ready. I’m just saying it’s nice. And then you can come at your new business in the calm confident way that someone who isn’t desperate or starving does, and the world will be rocked by you and your confidence and your skill and your gifts and they will rally around you, and you will bask in your dreams. (I didn’t take it too far – I believe in you).
In all circumstances if there are additional family members that you take care of be it parents, children, or others, the formulas work out the same, just expand that emergency fund from what your monthly expense is by how many months you want in reserve.
As to where that reserve should be that’s up to you, you can have it as simple or as detailed as you wish, just keep in mind an emergency fund is for emergencies and should be accessible quickly and not at risk of being lost – by squirrels or the stock market.
OK! I’m getting to your reaction now. TWELVE MONTHS! Three years! I have not been certified as crazy, just as a financial planner. I get it. It is a lot of money. It doesn’t all have to be in a coffee can in the back yard not working for you. Like I said a minute ago, it needs to be safe and accessible, but not necessarily dormant. There are some really good high yield savings accounts right now, and if you have more than a three month emergency fund in your checking or savings account, you could put some in a three month CD at your bank is just one example of an insured, protected, interest earning, way to have your savings working for you while it’s doing it’s other job, giving you peace of mind.
I’d consider that all emergency fund money.
But there are other types of savings too. Short term goals are things you want in the next year. Mid-term goals are things you hope to do or achieve in the next 3-5 years. Long term goals are after five years until the rest of your life.
You can save for your emergency fund (after you have that first month) and save for other goals or invest at the same time. All or nothing thinking is not welcome here.
Just tell that 20% (or 30%) of your savings where you want it to go. Your money is working for you, remember. You are not working for money. Again, your money is working for you.
The emergency fund should not be “invested” in the stock market. Some banks offer “buckets” where all your savings can be in one account, but it is ear marked for different goals. This is a way to simplify saving and have everything in one place. Some people prefer not to have easy access and may choose to put the vacation fund in a separate bank, so it is out of sight until the day comes to pay (in advance) for their trip. Know thyself. What feels right for you?
Short term goals have the same safety requirement as an emergency fund. For example, if your short-term goal is to buy a home in three years, please do not save for a home down payment and put your savings in the stock market – markets bounce up and down, and when you want that down payment, you want all of it, when you want it.
If, however you are saving for a goal that is out three to five years or beyond, you can consider if you want to invest your savings for that goal.
Saving for your retirement in cash would for most people not be a realistic way to save. They would have to save so much more to have enough to retire on one day. That’s one way that not investing can be risky. By not investing in your long-term goals, you have the risk of not keeping up with the rising cost of living throughout your life.
An emergency fund is as unique as the person saving, whether you are plain vanilla or caramel chocolate chip swirl, you can find the amount and the place that is right for you and what feels safe for you.
It important to connect to your why. Why this money is for this need, as dormant as it may seem, it is the dragon lying in wait to rescue you if you need to rescue yourself one day. You are your hero. You keep yourself safe. You provide. You do not give this money away for love or charity. Those are entirely other subjects… you are worth feeling safe and you can provide stability and security for yourself.
Photo Credit: Gpoint Studio