You may have heard that having an emergency fund is extremely important for your financial well-being. I’d like to reaffirm the statement because it is crucial to have a sense of security. Your emergency fund should have between 3-6 months of living expenses. For a larger household, you may want to consider 9-12 months of living expenses.
Make sure to have a pen and paper handy as you follow these 7 steps to get started with your emergency fund. Below the info graph, I will take a deeper dive into each step.
Step 1: Calculate Net Income
Before we begin, you need to know what your top line number is. In other words, how much are you making and bringing home every month? Always calculate your net income (after taxes, deductions, etc). You can do this by checking you pay stubs or check your bank account to see your direct deposits. Once you’ve got this number added up, write it down at the top of your paper.
Step 2: 10%-15% Savings
Now, before we go into your expenses and living costs are, I want you to be aware that you should be saving between 10%-15% of your net income every month. Why 10%-15%? This will position you the best way possible to support all of your financial goals in the long-term, including vacations, home purchases, paying down student loans, other debts, etc. Some financial professionals advise to save 20% of your net income! If 10%-15% is too challenging due to the market conditions and living costs, then try your best to get to that sweet spot.
Step 3: Calculate Living Expenses
Once you know what that 10%-15% savings number is, calculate your living expenses. Make sure to include: auto insurance, auto payments, gas, parking, tolls, credit card payments, cell phones, internet, cable, utilities, student loans, personal loan payments, food & dining, groceries, health and fitness, rent, mortgage, HOA dues, home improvement projects, miscellaneous, and any other category.
Step 4: How Can I Reduce My Costs?
By this point, we’ve got the following numbers:
- total net income
- 10%-15% of savings goals
- total living expenses
Subtract your total living expenses from your net income. If this number is less than the 10%-15% savings goals you have calculated, then you will need to take a good look at your expenses and find ways to reduce your cost.
A few ideas about where you can reduce your costs are in cable bills, credit payments, eating out at restaurants, spending money at the bars and clubs, shopping sprees, and buying $5 coffees every day.
Step 5: Create A Budget
Creating a budget will keep you honest with your spending behaviors. If you find yourself spending above your means or not saving at least 10%-15% of your net income every month, then this guideline will be extremely beneficial for you.
When you create a budget, it doesn’t end there. You will be required to track your expenses on a regular basis (daily, every other day, or weekly) to make sure you are on track with the budget you set. To get you jump started, I’ve added 2 excel spread sheets that contain pre-made budget worksheets. I encourage you to download them for free and begin here.
Step 6: Set Attainable Goals
After you’ve created your budget and have set a game plan to save every month, think about setting an attainable goal to achieve the full funding of your emergency fund. Do you plan to save 3-6 months of living expenses? Or, perhaps 6-9 months of living expenses? If so, how soon will you accomplish this? Are you thinking in 1 year?
These are questions you need to ask yourself and make sure the decision you make is realistic. You don’t want to set a ridiculous goal and feel overwhelmed by it. Make bite sized goals and set milestones for achieving them.
Step 7: Stay On Track
Staying on track is the hardest part of it all. Life is unpredictable and who knows what size wrench might be thrown your way to knock off the hard work you’ve put to plan. The key is to remain disciplined. The dedication you may have to go work out every morning or every day after work, to eat healthy, is the same type of commitment you will need to build your financial well-being and to become financially fluent.
Create a method to track your expenses day by day, week by week, and consistently measure it against your budget. Keep yourself honest and hold yourself accountable to your own financial goals.