I’ve already touched on how to use high interest savings accounts to keep your emergency fund safe. I also mentioned that if you have debt, you need to establish a small emergency fund first and then worry about paying off your debt. As mentioned, your small emergency fund should be $1,000 if you make over $20,000 per year and $500 if you make less than $20,000 per year.
Once you have your baby emergency fund established and tucked away in a high interest savings account you need to get your debt snowball rolling. (I discussed the debt snowball solution here.) While some people have some criticisms of the debt snowball solution, it is still an effective way to start reducing your debt.
When you’ve used the debt snowball solution to reduce your high interest debt to zero, you can start to increase your emergency fund so that eventually it will be able to cover three to six months worth of expenses. I know having enough money to cover three to six months worth of expenses can seem like a daunting task, but it’s not. Here’s how to figure out how much money you’ll need to stash away in a high interest savings account.
Calculating a month’s worth of expenses
Here is how to calculate how much an emergency fund you’ll need:
The first thing you need to do is to look through your budget and bank account records and develop a list of all your monthly expenses. Once you have the list, cross off any non-essential items that you can go without. For example, cell phone plan extras like voicemail, caller ID or data plans. This new trimmed down list of monthly expenses is what you will use in the rest of your calculations.
Next you need to determine how many months worth of expenses you are going to tuck away. The minimum you should stash away inside a high interest savings account is three months worth of expenses and the most you would need to save is six months. The exact number of months you need to save depends on you and the type of job you have. For example, if you work in a volatile industry where there are regular layoffs you should save the maximum, six months. If, on the other hand, you live in a two income home or have a lot of job security you would only need to save three or four months worth of expenses. Other things to think about are the job market in your area and industry, security of your spouse has at their job or if there will be new financial commitments coming up.
Finally, this is the easy part, once you know your monthly expenses and how many months you want to store away, just multiply the two numbers. Personally, I work in a volatile industry and in a commission-based job so my aim is to save six months worth of expenses and my monthly expenses are $2,000. This means I need to save $12,000 to create an adequate emergency fund.
Revisit, review and revise
An emergency fund will cover you and your family when unavoidable tragedy strikes. To make sure that you are adequately covered, you need to:
- Revisit your emergency fund calculations every year
- Review your list of monthly expenses
- Revise your emergency fund where necessary. If you ever review your emergency fund and see that you have more saved than necessary, you should move it to a registered retirement account to shelter it from tax. But I’ll go into this in more detail at a later date.
As I mentioned in my previous post, high interest rate savings accounts are the best place to keep your emergency fund because it is a further step removed from the rest of your money. This means that when you have a moment of weakness, it will be harder to get at the money you have saved for emergencies.
Emergency funds, high interest savings accounts, debt reduction and life insurance are the very basics of personal finance. By making sure you reduce your debt, save enough and have proper insurance coverage you lay a healthy foundation for the rest of your financial life.
How do your determine how large your emergency fund should be? Are you comfortable will how much you have saved? Let me know what you think, comment below.
I have decided to start this blog with a series of posts that deal with the basics of personal finance. This is the first post in this series. To make sure you catch the rest of the series and future posts subscribe to our feed and follow Savings Chronicle on Twitter.
Related posts:
- High interest savings accounts are the best place for your emergency fund High interest savings accounts are the best place for...
- The debt snowball solution is a great way to start working on debt reduction The debt snowball is a popular solution to start working...
- The difference between term and whole life insurance The difference between term and whole life insurance is...
Related posts brought to you by Yet Another Related Posts Plugin.
Thanks for the link – looks like a good site.
Mike