Reader Question: "How do I start an emergency fund... and do I actually need one?"

One of the great things about learning the language of finance is that money is everywhere. Well, not literally (although wouldn’t that be nice). But money is in every piece of news, every relationship, every milestone; every story has a money trail. It’s not like chemistry, where in order to really understand a concept, you need to go into a lab, put on your goggles and light some shit on fire. Money is different. We see money everywhere. No Bunsen burner necessary. So why should we keep these stories in a vacuum? We shouldn’t.

So on The Money Minute, I’ll be using reader questions as case studies to explain financial topics… and give you the chance to have your questions answered one-on-one. This kind of stuff is what gets me up in the morning, so I’m excited to get started!

Here’s our first reader-submitted question. It comes to us from Ben in New York:

Hey Nicole! I listened to your Money Rehab episode about how to make a budget and it really helped me wrap my head around a spending plan. I went through the steps and I know how much of my income I should be putting towards an emergency fund, but… how do I start?

One of my very first Money Minute posts was on how to make a budget. In that post, I gave you my recipe for a successful spending plan: 70% goes to essentials, 15% goes to extras and 15% goes to an emergency fund.

Unsurprisingly, very few people question the 15% for extras. I think we’re all just so sick and tired of so-called financial experts telling us we can’t spend any money on extras... so people take that 15% and run with it. As you should!

But I do get questions about the 15% for an emergency fund. The first question is always: what’s it for?

Well, think about it. If you lose your job, you’re going to find that even though you don’t have any income, you still have expenses. And you can’t pay for your groceries with an asset. And by asset I mean, something that you own outright that you could sell if you needed to bring in some extra money; like a car, a house, or a boat.

Although that boat would be worth cold, hard cash if you sold it, it’s not cash now, is it? When you check out at the grocery store and the cashier asks you “credit or debit?” you can’t say “boat” right? You’d need to sell that boat for cash. But if you’re in desperate need for some money ASAP, it will more than likely take way too long to sell. Plus, I mean, how many people are looking to buy boats right now?

So you need some cash squirreled away. A doomsday fund, a treasure chest, an “oh, shit” fund, a “break in case of emergency” fund. Whatever you want to call it… you need one. Do it now. If you’ve never thought about building an emergency fund, you may be wondering where to keep it. You may be picturing it in some sort of doomsday bunker. And we’ll get to that bunker shortly.

But before I tell you where to put your emergency fund, you first need an emergency fund. And this should be financial priority numero uno for you. Before the fancy stuff like investing in the stock market, or even before putting money into a retirement account, you need an emergency fund. Again, ask yourself: if you lose your job, can you pay for groceries with a 401k? Nope! Not while you’re still living your best pre-Betty White life.

You’re probably wondering, “How much we talkin’ here, Lapin?” Well, a good rule of thumb is to have three to six months of living expenses readily accessible. So… how much are living expenses? Well, you can easily figure out your living expenses now that you’ve worked out your spending plan here on The Money Minute!

I say three months only if you have a steady job and a steady paystub-- say a tech gig, or in a trade industry; basically an industry where you feel confident that you’ll be able to secure a job quickly if, God forbid, shit happens. If your work is a little less consistent, like if you’re a bartender or a freelancer, I’m going to strongly suggest that you tuck away six months of whatever money you need to live on.

If you work mostly on commission, like real estate brokers or salespeople, you’re probably going to need more reserves; a year is probably a better number for you.

Again, we are talking about just the basics here: enough to cover bills to live, eat and transport yourself from A to B. My hope is that you don’t need the newest iPhone when you’re dealing with bigger, more important stuff. So just the basics.

With your handy dandy spending plan that you made, you should be able to figure out how much of a nestegg you need for your emergency fund, and how long it will take you to reach that dollar amount if you put 15% of what you make every month (you can take this out of your “Endgame” allocation) toward that fund.

Once you’ve figured that out, we can chat about that doomsday bunker. Where do we store our emergency fund?

It’s pop quiz time!

For easy math, let’s say you’re bringing in $5,000 clean each month. You’ve made a commitment that you are going to save 15% of that, which is 750 bucks a month. But where do you put this savings?

Is it….

A. Under your mattress… in actual dolla, dolla bills

B. In a savings account

C. In a CD

D. All of the above

If you guessed D, you are correct-a-mundo! It’s a combination, a mix-and-match of all of them.

Well, okay, I was kidding about literally stashing cash under the mattress, but I am serious about keeping cash. Famous economists might revolt in the streets when I say this, but I am still a fan of having some green cash in your house. Why? Because at the end of the day, you can’t get more liquid than cold hard cash.

No matter what happens to the banks, the stock market, or your credit cards, you can always rely on cash... being cash. I’d say a couple hundred bucks is a good amount to keep on hand; it’s not so much that it’s a major liability to be stolen, but it just feels like enough to cover many emergency situations, like having your car towed before work, or getting by for a week after losing your debit card.

But the hero of the emergency fund is the savings account. So, let’s break it down.

Honestly you’re not going to get rich by putting your money in a savings account… and that’s because interest rates on savings accounts are low.

This is the concept of your interest making interest. When it comes to borrowing money, we hate this concept. When it comes to making money, we love it. When you are making money from the glorious force that is compounding interest, it is called APY, or annual percentage yield.

Let’s say you put $10,000 in the bank at 2% APY. After year one, you will make $200 in interest, for a new total of $10,000 + $200 = $10,200.

After year two, you will make another 2%... but now you have $10,200, right? So now your 2% is $204 and you now have $10,200 + $204 = $10,404. And the next year, you will make 2% off $10,404. And so on.

But, I will always be honest with you… you’re not going to find 2% APY right now. The rates are insanely low, around 0.25% (although if you dig hard enough, there are still some 1% high-yield accounts out there), so don’t expect to make bank (pun intended) here.

So, the money you put in a savings account isn’t going to “work for you,” but it will be there, and it will be accessible. That accessibility piece is key, because obviously we can’t plan an emergency around a date, right? So you need to have your emergency fund accessible to you when you need it.

So where to put our beautiful emergency fund? How do we make this dream a reality? Here are three steps I would take:

1. Look at the different places you can get savings accounts and see which one you feel comfortable with. The biggies are: credit unions, regular banks and online banks. I’d bet that the options you are looking at are insured, but just double-check. In case something happens to the bank, you want to make sure your money is safe. The Federal Deposit Insurance Corporation (FDIC) insures banks, and the National Credit Union Share Insurance Fund (NCUSIF) insures credit unions.

• Quick side-note on this point: If you have a checking account at a bank that you love, look into what savings accounts that bank offers. You may be able to get perks from the bank by keeping both checking and savings accounts with them. Plus, you will likely be able to transfer money from checking to savings free. Even if both of your accounts are through the same bank, I find that the physical separation from your checking account is often enough to keep your savings in… savings.

2. Open the account. Duh. No surprises there.

3. But this one may be a surprise: Don’t sign up for overdraft protection. By law, you now have to opt in if you want to have the bank cover an overdraft charge when you don’t have money in your account to pay for your purchase—and then, of course, they charge you a fee. Don’t do this. If you don’t have the money, you’ll likely not have enough to pay the fee. Even if you do, the principle of overdraft protection doesn’t sit well with me. It’s basically a quickie loan to you in exchange for an exorbitant fee. It might be embarrassing in the line for coffee when your card doesn’t go through, but a $35 fee for that $2 Danish just ain’t right. If you’re spending $37 for a Danish, it had better be for several dozen of them.

I know all this saving for a rainy day stuff is a drag. And none of us want to plan for an emergency, because we want to live in a world where shit never goes wrong. But let’s say you look outside, see the sun shining, and decide, “To heck with being safe. I’m leaving my umbrella at home!” You risk getting caught in the rain. And when it rains, it pours...

Aaaaand that’s all the time we have for today! I’ll see you soon for your next Money Minute.

xo,

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