With our economy crumbling faster than a drunk girl going down the stairs, many of us have recently realized how critical it is to have an emergency fund. Maybe you lost your job and are now faced with a new reality. Maybe you’ve seen many of your friends and family members lose their jobs, and are worried the same could happen to you. No matter what brought you to the realization that you need to start an emergency fund, be glad that you’re here, because you may one day find yourself asking, “how the F**K am I going to pay for all of this stuff?!”
The fact is that most of us prepared for this pandemic the same way the government did. We didn’t. Few of us have an emergency savings. Only some of us were investing in the 401K at our company. We were using a big chunk of our salaries to pay off our student loan debt, but still bought a too-expensive house because we just couldn’t pass it up. In times of prosperity, we tend to ignore the possibility of economic hardship. But the fact is that it will come. It always does. The good news is that you can begin a financial self-care routine to better prepare for the next time the economy takes a nosedive. The first step is to build an emergency fund. And this is how to do it.
Step 1: Understanding Your Spending
The first thing you need to do is calculate your monthly spending. This includes only necessary spending like rent or a mortgage, student loans, food, insurance, electricity, etc. The bills you must pay and the necessities you must have to survive. This should also include things like internet and Netflix, but not what you spend at weekly happy hour, eating at restaurants, or shopping. List out all of your monthly expenditures, and add them up. The total is your base amount of monthly expenses assuming no unexpected expenses arise. But we know nothing ever goes to plan. That is why you’re doing this in the first place! To account for unforeseen expenditures like replacing a tire, a medical procedure, or your annual Amazon Prime membership fee, multiply your base amount by 1.25. This will give you an additional 25% for the unforeseen expenses you know you’ll have.
Bridgette’s monthly spending is as follows:
- Rent: $1,000
- Student Loan Payments: $250
- Car Insurance and Gas: $300
- Electricity/Water: $150
- Groceries: $500
- Internet/Netflix/Spotify: $100
- Cell Phone Bill: $150
- Gym Membership: $50
Total Predicted Monthly Spend: $2,500
Additional 25%: $625
Total Actual Monthly Spend: $3,125
Step 2: Open a High-Interest Savings Account
Now that you know what your monthly spending is, you can start building your emergency fund. A good rule of thumb is to have 6 months of expenses saved. Take the monthly spend you calculated in the previous step with the additional 25% included, and multiply it by 6. This is the goal amount you want to have in your emergency fund savings account.
Bridgette’s monthly spend is $3,125.
$3,125 x 6 = $18,750
Now I know what you’re thinking. HOLY SHIT! I’ll never be able to save that much! But it is totally possible! It won’t happen tomorrow, but over the next several years, you’ll be surprised what savings you can accomplish with minimal effort, and I’m going to show you how.
The next step to reaching your savings goal is to open a high-interest savings account. Mine is through Citizens Access, a division of Citizens Bank. (Bonus, Citizens Bank is a black-owned business!) If you do a quick Google search of high-interest savings accounts, you can review your options and choose the one that fits your needs best. Once you’ve selected the best option for you, open your account.
Many of you will want to skip this step because you already have a savings account with the same bank you have your checking account with. You think it’ll be easier to just use the account you already have. DO NOT do this! Citizens Access currently offers a 1% return on your savings, while Chase Bank offers a .01% return. That means that for each $100 in your account, Chase will give you $.01 while Citizens Access will give you $1. If you had the option to take a penny from someone or a dollar from another person, that would be a no brainer! You would take the dollar. Choosing to open a high-interest savings account is the exact same decision. The 1% return is well worth the 10 minutes it will take you to set up the new account because the higher return will help you reach your savings goal faster.
Another reason why it is important to get a higher return with a high-interest savings account is because of inflation. Inflation causes your money to lose purchasing power (PP). (Check out this post on why combating inflation is one of the most important rules of finance.) Purchasing power is how much you can buy with your money. You know the stories your parents and grandparents always tell about how they remember when gas was $.50 a gallon, or when they could buy candy for a penny? These stories sound crazy to you because you could never buy gas for $.50 a gallon or candy for a penny today. This is because inflation has caused a decrease in the purchasing power of the dollar. AKA prices went up. In the future, you’ll also be telling your kids and grandkids stories like this. That means that the money you’re saving now will be able to buy less and less as time goes on because of inflation.
The annual rate of inflation is usually around 2%. So each year, your money can buy 2% less than what it could the year before. This is where the high-interest savings rate comes in handy. The 1% return Citizens Access gives you on your savings will help you combat the effect that inflation is having on the purchasing power of the money in your savings account. Inflation is an unseen expense on your money, so people tend to ignore it. But at the end of the day, you’re saving this money so that you can spend it one day when you need it. If that day is 10 years down the road and you’ve experienced 2% inflation each year, you’ll have nearly 20% less purchasing power than you have now.
- Bridgette has reached her savings goal and has $18,750 saved at the beginning of the year.
- Inflation was 2% this year.
Bridgette’s purchasing power due to inflation is
$18,750 x .98 = $18,375
With Bridgette’s .01% return on her Chase savings account, her purchasing power is
$18,750 x 1.0001 x .98 = $18,377
PP increase from Chase return = $2
With Bridgette’s 1% return on her high interest savings, her purchasing power is
$18,750 x 1.01 x .98 = $18,559
PP increase from high-interest savings return = $184
By putting your money in a high-interest savings account, you can combat a significant portion of the effect inflation will have on your money. When interest rates increase, so will the return offered by your high-interest savings account. If your savings rate of return is equal to the inflation rate, you will maintain all of your purchasing power. If your savings rate of return is above the inflation rate, you will be increasing your purchasing power. So what I’m trying to say is, OPEN THE DAMN HIGH-INTEREST SAVINGS ACCOUNT!
Step 3: Move Your Current Savings and Set Up an Automatic Deposit
Now that you have opened your high-interest savings account, it’s time to put some money into it! If you have a current savings account alongside your checking account, move your savings balance to your new high-interest savings. Since the new high-interest account will only be used for life-changing emergencies, like a job loss, large medical expenses, etc., the money in the high-interest account should be considered off-limits for fluctuating expenditures. To give yourself some cushion, leave a small balance in your original savings, and move the rest to your high-interest savings.
Once you’ve rearranged your current savings balance, it’s time to increase your nest egg! Set up automatic deposits into your new savings. You can update your direct deposits with your employer, or set up regular transfers from your checking to your new savings. Either way, you should be realistic with what you’re able to contribute while still pushing yourself to save more than you really want to. You started this journey thinking you would never be able to save enough, so don’t self-sabotage by only saving $20 a month if you know you can contribute more.
Step 4: Increasing Your Contributions
Now that you’ve figured out your monthly contribution amount, you may be discouraged again. If the amount you need to save to reach 6 months of expenses is around $20,000, and you’re contributing $100 per month, some quick math will tell you that it will take you over 16 years to reach your savings goal. First, take the time to appreciate that you just started building an emergency fund for yourself, and are contributing 100% more than you were before! That is no small feat! Everyone starts somewhere. The point is to get better and make your life easier over time. If you only have 3 months of expenses saved by the next recession or major life change, that is 3 months of covered expenses that you wouldn’t have had before. You’ve already put yourself in a much better position than you would have been in had you never begun to save.
Now that you understand how amazing you are for taking the first 3 steps, I’m going to help you reach your savings goal faster. The key to doing this will be to increase your contributions.
Over the next several years, your financial situation will change. This can be due to things like getting a promotion and a raise, or paying your car or student loans off. When your salary increases or your expenses decrease, or amazingly both happen, your disposable income will also increase. Disposable income is the amount of money that you have leftover to spend on things like going out to a nice restaurant, going shopping, or taking a vacation. I’m going to call your disposable income your personal profits.
In business, profit = revenue – expenses. This concept is exactly the same in personal finance. Your revenue is your income. When that goes up and your expenses stay the same, your personal profits increase. When your expenses decrease, your personal profits increase. Usually, when your personal profits increase, your first thought will be to increase your expenses again. Maybe you move into a bigger, more expensive apartment. Maybe you start shopping at more expensive stores. Maybe you take more vacations. But whatever your indulgence, you will quickly put your extra personal profits into that by spending more. While this is super fun, it won’t help you reach your financial goals.
When you have an increase in personal profits, first treat yo’ self! You deserve to celebrate! Take your extra money and take a weekend getaway, or buy those shoes you’ve been eyeing. It is no fun accomplishing something if you don’t allow yourself to acknowledge the achievement. The key is to not make the celebration last forever. Pick a timeframe or item to splurge on, and then set yourself up to achieve your next goal. If you got a raise of $1,000/month, increase your savings contributions by $500 and take the rest for added fun. If you were contributing $100 each month before your raise, and increase your contributions by $500, you’ll now be contributing in two months what you used to contribute in a year. If you pay your car off, take the monthly amount you were paying and put that amount into your savings each month. You already know you can live at your current spending level, so reallocating your expenses will allow you to maintain your quality of life while setting you up to reach your financial goals.
The highest form of self-care is self-discipline. You’ve just begun your financial self-care routine, and if you’re disciplined and stick to it, I guarantee you’ll reach your savings goal. It may take you the next 10 years, but if you’re not actively making decisions to become the person you want to be when you’re 30, 40, or 50, you’re not going to get there. Imagine how you’ll feel at 40 knowing that you haven’t created the life you wanted because you never tried to reach any of your goals. You’ll probably feel pretty shitty, and need a lot more self-care in the form of therapy. The road to reaching your financial goals will be long. There will be recessions and expansions. Raises and job losses. Having an emergency fund will allow you to succeed during the downturns and give you peace of mind. Everyone might talk shit when you don’t want to go out every Saturday because you’re saving for your emergency fund, but they’ll be jealous when you’re the one shopping during the next recession.