Baby Step Three: A Fully-Funded Emergency Fund
You’ve lived with a $1,000 starter emergency fund (Baby Step 1) while you’ve paid off all of your non-mortgage debt using the debt snowball (Baby Step 2). What do you do now? Well, now it’s time to use that same momentum and quickly pile up cash to build up your fully-funded emergency fund.
Whatever you do, do not skip this step! We call Baby Step 1 a “starter emergency fund” because that’s what it is. We’ve always known we need more than just $1,000 for emergencies. We know that life happens…it’s going to rain…so we need an umbrella.
There are a couple of things to remember about your fully-funded emergency fund, though:
1. This is NOT an investment. Your fully-funded emergency fund is essentially insurance. You want the cash to be accessible and liquid, but not so easy to get to that you are tempted to spend it.
2. Because this is an emergency fund, remember that we ONLY use it for emergencies. The sale on 3-wick candles at Bath & Body Works is not an emergency.
3. There are many places to park this money - and while we aren’t worried about it being an investment, there are definitely better interest rates that you can get on this money if you park it in a money market account, an online savings account, or even mutual funds (though I don’t recommend mutual funds for your emergency fund). Ashley and I personally use Ally bank - which is an online savings account.
4. This is the MOST IMPORTANT rule of all: if you have to use the emergency fund, the priority should then be to refill it immediately. You’ve worked so hard to get to this financial peak - don’t get distracted - make sure to always fill your emergency fund back up.
But how much money should be in your fully-funded emergency fund? Simple answer…3-6 months of household expenses (minimum). But that seems like a lot of money, right? Well, look at what we’ve done prior to this step: we’ve started living on a budget, we’ve stopped borrowing money, we already have $1,000 of our emergency fund, and we’ve paid off all of our non-mortgage debt. With all of this work, you’ll be shocked at how quickly the account will grow - because none of your money is going to payments, and you’re living on a budget.
Another question you might be asking is how do you decide between 3-6 months. If you have a job or career that is less stable (artists and freelancers, I’m looking at you); or if your job is a commission-based job, you’ll want to lean more towards the 6 months of savings. If you have more stable job and financial situation, 3 months would be adequate. But at the end of the day, it’s whatever amount gives you peace - but remember that there is such a thing as “over-saving” for our emergency fund. We don’t want too much of our money sitting and not working for us. That’s why most financial professionals will agree that 3-6 months of household expenses in your emergency fund is sufficient.
I wouldn't suggest saving more than 12 months' worth of household expenses in your emergency fund. There is such a thing as "over-saving."
Lastly, I’d like to note that savings, an emergency fund, and investing are all different things. Savings is simply liquid cash-on-hand. An emergency fund is money you do not touch unless it is for an emergency. And investing is money you put into some kind of retirement account (which we do not touch until retirement).
We are always working towards a better financial story. We keep setting goals as we go so we don't lose sight of the long-game.
As we continue onto the next Baby Steps, we don’t want to leave ourselves vulnerable to a crisis. Having a fully-funded emergency fund is that protection. It’s a necessary component to having financial independence.
Here is an article explaining the details & importance of a fully-funded emergency fund along with how to quickly build one up: https://www.daveramsey.com/.../quick-guide-to-your...
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Kyle is the founder and certified financial coach behind Financial Flippers. You can learn more about Kyle and what he offers by visiting his website: www.financialflippers.com
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