5 Essential Steps to Building your Emergency Fund

The goal of this week’s newsletter is to help you take your first steps towards financial stability and avoid being part of the 40% in the study above. Here are 5 essential steps to building your emergency fund.

1.     Shift your money mindset

An emergency fund gives you the mental space and freedom to not worry about how you would pay for your car breaking down, a medical emergency, or any number of unexpected expenses that arise in life.

To go from having no money to having enough money to start building an emergency fund takes a mindset shift around how you perceive money.

Visualize the peace of mind your emergency fund will bring you and believe in your ability to become a financially intelligent person. This will help you shift your mindset from thinking of ways to spend money, to thinking about your next investment.

2.     Set a realistic savings goal

Using the 50/30/20 method of spend categorization, aim to save around 3 to 6 months of your monthly needs spending. For example, if you earn $4k/month and spend half of that money on ‘needs’, your emergency fund should consist of $6k-$12k. If you have no money saved, this may seem like a lot of money to put together, but you’ll be surprised how quickly it adds up once you start diligently saving 10 to 20% or more of your monthly income. For example, if you’re able to save 20% of your monthly income, in just 15 months, you’ll hit the 3-month emergency savings account milestone.

3.     Create a budget and prioritize savings

“But how will I save 10-20% of my monthly savings?”

First, cut down on your top 2 expenses. If you live in North America, these are likely Housing and Transportation. Try to keep base rent at or below 25% of your monthly net income and transportation at 12.5% or less of net income. (Note: the transportation category includes vehicle loans, insurance, and gas) Move or buy a cheaper (but reliable) car if necessary. The more you’re able to save in these areas, the less you’ll have to cut back on your wants.

In addition to housing & transportation, identify your top 3 ‘wants’ category spending items and figure out how you can trim your spending in each category. Allocate the savings from these categories towards your emergency fund. Remember not to completely remove all fun and joy from your life, but do take a sober look at where your money is going and think about whether it’s reaching its highest purpose in your life.

4.     Setup a High-Yield Savings Account (HYSA) with automatic contributions

You work hard for your money, so make sure your saved money is working hard for you. While most traditional savings accounts only earn less than 0.5% APY, high-yield savings accounts can earn over 4.5% with today’s interest rates. I recommend using Wealthfront since they also provide a dashboard that lets you see all of your checking, savings, investing, and credit card accounts. I’m pretty sure real estate accounts can be tracked as well. (Full disclosure, I’m not sponsored by Wealthfront but that link will help both of us get an additional 0.5% boost for a total 5.05% yield)

That interest rate difference can mean the difference between a couple hundred a year in interest and a couple thousand, it adds up quick.

Once your account is setup, make sure you setup automatic deposits a few days after your get paid either month or biweekly so that you don’t have to even think about moving your money to your savings account. This will help remove the temptation to ‘skip’ a payment period transfer.

5.     Commit and build the fund

While at first it may be tough to make sacrifices in wants category spending, you will quickly adapt as all humans do. Visualize your financially-stable future-self and slowly shift your habits to align with wiser financial decisions.

For example, doing things like cooking more meals at home instead of eating fast food and spending time with friends cooking or at the gym instead of drinking and eating out will help save money while simultaneously helping you live a healthier life.

Thanks for reading, remember to take action now by setting up your HYSA if you don’t already have one. You can also build your monthly budget, track your net worth, and target asset allocation with my Personal Finance Tracker on Gumroad.

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