Emergency Savings: How to Sleep Well at Night

Recently I was browsing /r/FinancialIndependence and read a post from someone with modest, yet respectable income who was concerned about their ability to retire early.  They felt they were playing a good defensive strategy (controlled spending) but that their weaker offense (modest income) would prevent them from an early retirement.  Financial planning is not just a pastime for the wealthy.  There are powerful tools for those at all income levels, although the goal posts are set in different places.

Everyone has different personal and professional goals, and consequently everyone lives within different realities.  Financial planning is a means to maximize your own financial potential and to make the most efficient use of your money to meet your goals, whether it’s retiring early, buying a house, or building an emergency fund so you can weather life’s curveballs.

And that is the focus of this post.  In January, Bankrate reported that 60% of Americans do not have the emergency savings available to cover an unexpected $1,000 expense.  Despite record low unemployment and record high stock prices, most would have to resort to drawing on debt such as credit cards or personal borrowing, or would need to cut spending in another area of their budget to cover the sudden expense.

But that will probably never happen to me, right?

According to the article, 30% of respondents had experienced at least one major unexpected expense during the past year.  In a perfect world we could predict the future, but unfortunately in the real world things happen that we can’t control.  Cars break down and air conditioners go on the fritz, but these don’t have to become financial disasters.  With proper planning these will be minor speed bumps on the road of life.

So how much do I need to save?

This depends entirely on your situation: do you have kids?  Own a car?  Own a house?  All of these factors play into how much you should have saved for your emergency fund, but baby steps will get you where you need to go.  While most advice will tell you to save at least three months’ expenses, consider some savings checkpoints along the way:

  • $500 – Groceries are covered for an entire month.  You’ll never struggle to put food on the table.
  • $1,000 – Laptop died?  Go down to the big box store today and pick up a new one.
  • $2,500 – Most common car repairs are no problem.  Need new tires and brakes?  No problem.
  • $5,000 – Need to find a new home on short notice?  You’ve got sufficient savings to cover first and last month’s rent as well as the security deposit on a new apartment.
  • $10,000 – Unexpected job loss is not a crisis.  You are able to cover all essential monthly expenses for a couple months.
  • $25,000 – Virtually all day to day expenses are covered for several months, including multiple simultaneous emergencies.  When it rains it pours, but you’ve got a huge umbrella and matching rain boots.

Cash in the bank equals a good night’s sleep.  No matter what happens tomorrow, you’ve got the means to take care of it.  This goal won’t put a shiny Cadillac in the garage and it won’t give you early retirement, but it is a serious achievement in itself and will go a long way towards eliminating your day to day financial stress.  This is the first step towards your financial independence!