How to Set up an Emergency Fund

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Regardless whether a person has FIRE aspirations or not, cutting expenses is a smart move and shouldn’t be overlooked.

Damn, that hurt!

Sorry, I bit my tongue really hard there… Let me paraphrase it in a less implicit manner: cutting expenses should be everyone’s top priority! Not only because it’s the one and only possible first step towards financial freedom, but it can drastically improve a consumer’s life even if he’s not (yet ;)) pursuing FIRE.

Let me illustrate with an example of a common, expensive, unrewarding habit many people acquire. By giving up smoking for a year, the average employee can treat himself with a “free” 2 week all-inclusive luxurious vacation and sip sweet pineapple Piña-coladas under a palm tree while the resort’s personnel stimulate his consumer needs by providing an abundance of exotic food, drinks, and entertainment. Objectively way better than smoking and that doesn’t even include the health benefits! But I was biting my tongue again… If he invested his cigarette budget in the stock market instead, he could enjoy some hefty long-term returns and let the magic of compounding pay for vacations, not his paycheck! But we’re getting ahead of ourselves… The objective of this post is saving, investing comes later.

So, smoking is bad, mmkay?

We got that out of the way? Good! That was a long and strongly opinionated introduction. 🙂

The importance of an emergency fund (theory)

Do you know that feeling when you look at your bank account and have virtually no idea where a large portion of your money went? Me neither. 🙂 However, many people do and I’m writing this post to give them a few ideas / tips on where to start.

More than 60% of Americans don’t have the means to cover a 1000$ emergency¹ and 25% have no savings at all.² And that’s only in the country with the best economy in the world! I wouldn’t consider it unreasonable to assume a similar, or even greater, portion of people without sufficient funds to cover the cost of living adjusted value of 1000 dollars in their currency an emergency in other countries.

There is nothing that can give a peace of mind in such a way that an emergency fund can! I mean it! Just imagine what would a guy with no savings do on the 18th day of the month (next salary is due in more than a week) and his home gets damaged in a storm. Wait, storm on the 18th? Oh yes, that reminds me of this January… It was not the most pleasant day in The Netherlands.

But I know… Emergencies don’t happen that often. I’m not being sarcastic. Most of them are rare or can be postponed (major household repairs, tickets, car or medical bills, unexpected travel due to a death of a family member, etc.), but additional expenses can also come in other more subtle ways as well, such as inflation, annual expenses (like taxes) or getting sick for a day while being paid by the hour, so it’s always good to be prepared.

Building an emergency fund is not hard to do regardless of how high or low one’s income is. It is completely related to spending habits and being responsible. For example, I maintained my savings even before I had a job by simply not spending them.

But how did you get the money, they must have come from somewhere?!

I just said it, you’re focusing on the wrong thing! Saving money is not related to earning, but to spending! That’s the exact reason why we know about multi-millionaires that went bankrupt! If saving was a function of money earned, every person who earned more than the full minimum wage (which in most countries is just enough to survive on) would never have financial problems in his life. However, people who earned way more than that (such as Mike Tyson, 50 Cent, or Nicholas Cage) show otherwise.

In case you missed it, this is exactly the peace of mind I’m trying to illustrate – you want to do something and it has a price tag on it? No problem! You don’t need loans, contracts, bureaucracy, or family helping you out. You’re self reliant and just do it! And it feels great. So… Where to start?

Simply put, the way you build an emergency fund is by spending less than what you earn. EZ! No? Okay, I understand, some habits are hard to break… Later in this post I’ll give a few ideas on expenses that should be easily minimized. The basic idea, however, is: don’t “spoil” yourself to the point where you are forced to use credit cards, borrow money from friends or family, or take out a loan when you crash your car. Oh, and do you need the car?

If spending less than you earn is too hard, you can use the idea of paying yourself first. That means when you receive your next salary, first allocate a portion of it for your savings and don’t touch it! Basically, give yourself a pay cut and feel free to spend all of what’s left. And what should be the amount you put aside? Ideally 100%, but we’re both far from it at this moment. So… Try with… 5%? Too much? 3%? You should consider changing your job if 3% is really not doable, which may be the case only if you’re earning less than the average salary in your city. If you’re earning at least an average salary, 10% shouldn’t be the slightest problem – try it out this month and be consistent with it! It becomes a sweet addiction – way better than smoking.

By the way, numbeo.com is a great place to find the average salaries per city. I frequently use it to compare the cost of living, purchase power, and average salaries in different places.

Apart from reducing stress during unforeseen situations, the emergency fund can increase your comfort as well. Having enough money to survive on for a few months (or even better, years) makes the life easier in so many levels. Not only you can “comfortably” get sick or handle a lay off, but you can also choose to chill-out for a month or two while switching jobs and feel freer in general. You got a ticket? You just pay it and that’s it! No interest, no delay fees, no credit card debt, no shattered relationships with friends or family. Oh, and I think it goes without saying, but while we’re at it: stay out of debt. Always!

Spend less than you earn, pay yourself first, and stay out of debt.

How to start saving more (practice)

Okay, enough theory! In the previous section I wrote that if you’re really living below or at the poverty line, changing your job should be your top priority. First thing to get out of the way: once you get a salary increase, don’t match it with your spending! Continue living at the level you previously did until you have enough savings to cover at least 3 months of living.

Second, and equally important, thing to get out of the way: always pay in cash! Don’t get loans, especially not for “investing”. And especially especially not for “risk-free investments”! Don’t even pay in cash for those. After you have your emergency fund, you’ll almost automatically acquire some financial intelligence and then you can start gambl… speculatin… yeah, investing. If you have some time, it may be really worthwhile to google the acronym FOMO (stands for Fear Of Missing Out). It will go a long way, but may be especially beneficial while you’re poor.

With those out of the way, let’s get down to the nitty-gritty – there is no magic formula for spending less (i.e. saving more). At the end, it all comes down to two things:

• Managing compulsions
• Managing subscriptions

Managing compulsions

It’s almost 4 in the morning, so I’ll be brief, but to the point!

Managing compulsions means fighting with the human nature and resisting to indulge in activities that encourage our laziness by offering fast rewards and make us hate ourselves afterwards. One such activity is, of course, smoking – usually done by pure compulsion. I won’t stretch it, just ditch that hobby. While at it, try picking up a new one – one that will improve your health.

Being disciplined is a mindset that goes a long way from taking care of your body! Doing grocery shopping becomes not just easier, but also less expensive once you cut all the inessential waste bought out of compulsion. Here’s a list of things you don’t need and shouldn’t buy if you’re finances are not on track:

• Chocolates & sweets
• Any types of snacks
• Juices or energy drinks
• Alcohol (including beer, needless to say)
• Tobacco
• Anything that you didn’t plan to get before seeing it

Oh, seems like I exhausted the list… That was fast! Seems easy enough, just cut these few items from your grocery list and you’ll have no problem saving a percentage of your salary, guaranteed. And of course, don’t eat out, at least for this month. And don’t drink (alcohol, anywhere).

Damn, I love frugal living because no other FIRE topic comes this close to being a monk! 🙂

“But I really like to have something to chew on while watching TV…”

Oh, I nearly forgot! Let me cover that as well…

Managing subscriptions

Unsubscribe from all services that you haven’t used in the last month.

Unsubscribe from all services that provide entertainment, even if you used them last month! You’ll always be able to come back to them after you set your emergency fund, just more carefully this time.

You don’t need cable TV, landline phone number, and you may be overpaying for your internet or mobile phone. And depends on your needs and lifestyle, you could also cancel the mobile phone contract and go prepaid.

You (most probably) don’t need new clothes, gadgets, phone, or household items. I know I don’t! Unsubscribe from the consumer lifestyle, at least until you can afford it by not heading towards debt when unexpected expenses would appear.

I have only 5 “services” I’m “subscribed” to and to which I allow automatic transfers: gas, water, electricity, internet and the mandatory health insurance. And I’m doing great! I highly encourage anyone with no savings to (at least try to) go this path and experience the pleasure of having more money than the previous month.

Summary

Three steps:

• Want to do this
• Pay off consumer debt (or not get into)
• Set up an emergency fund of at least 3 months

I have a lot more to say, this is a passion that’s burning hot inside of me, but this post is already getting too long. And indeed, it’s a nice conceptual wrap up aimed for people that got deep into the consumer paycheck-to-paycheck mentality and have almost no savings for emergencies.

In the next post I’ll talk about the benefits of having more savings and I CAN’T WAIT to start writing about what to do with your savings next! 🙂

See you there!

 

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1. https://www.cnbc.com/2018/01/18/few-americans-have-enough-savings-to-cover-a-1000-emergency.html
2. https://www.cnbc.com/2018/05/22/fed-survey-40-percent-of-adults-cant-cover-400-emergency-expense.html