Emergency Fund – Your First Priority
If you do not have one it should be a first priority in your personal finances.
Why? Well it comes down to basic needs. Maslow's hierarchy of needs begins with the very basic physiological and safety needs before going on to anything else.
So now that you have food on your plate and are paying the bills, you need to build the second block in the pyramid which concerns with your safety.
An emergency fund does just that, provides a safety net. I strongly believe you should not even be investing or saving anywhere else before you have fully funded an emergency fund.
But, not all emergency funds are created equal. I have broken down the levels of the emergency fund into 3:
1. Minimal-$1000-$2500
2. Average-3 months of living costs
3. Ultimate-6 months of living costs
These are all stages that should be climbed from 1 to 3 and then add to it with the growth of monthly expenses and increase cost of living such as inflation.
A minimal emergency fund is really just a small step towards creating the fund, kind of like a trial, to give you a small and quick success at your goal. The only emergencies level one can really cover are things like minor car repairs, or tickets and fines. It is not something reliable, hence it's temporary.
Level two includes 3 months of living expenses.
Here's what you should include to determine your fund:
-rent/mortgage
-car payment(s)
-home utilities
-cost of groceries (times 1.5)
-auto expenses (times 3)
-all insurance payments
-taxes (if you believe you owe at the end of the year)
-phone bill
-fixed or variable debt payments (just the minimum)
-Any other monthly payments towards school, kids, subscriptions
The reason I have you multiply groceries is because when you have a true emergency, you might be in a small state of shock and don't realize you are buying more food as a survival instinct.
I had you multiply gas times three because in case you lose a job, you will be doing a lot more driving between interviews (hopefully).
So take that list and added up and then multiply it by 3.
If you make it this far congratulations, you have created you basic safety net and can move up the pyramid. The only way to go is up to level 3 by having that list multiplied times 6.
Level 3 is not for everyone. It is only for families that have only one provider, or are in an industry where finding jobs will be hard.
Think about your position and imagine what you would do if you lost your job today. If you can't visualize getting another job quickly you need level 3 protection. Otherwise staying at 3 months should work just fine.
Put this money in a money market account and do not touch it. If you expand your expenses as you grow in life adjust the safety net to reflect on your new expense. This fund is only to be used in an EMERGENCY-not to pay taxes, fix the room, or make a down payment on the sweet ride.
Level 1 you should be able to obtain easily within 3-6 months. Level 2 you should be able to obtain in about 14-16 months, and level 3 could take you about 2 years. Now this all depends on your income/expenses and how aggressive you are in building the fund. But remember, the sooner you have it, the sooner you can move up the hierarchy of needs.
