The BIG Myth behind the Emergency Savings Account

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Personal finance gurus love to talk about this, but the truth behind building an emergency savings account is that it’s unimaginably difficult for most anyone to do! But that shouldn’t preclude you from actually doing it.

Why You Need to Start an Emergency Savings Account…

You have others relying on you for support, like children, a spouse or parents, who need your consistent support. Imagine what life would be like without your support.

As the US economy poises for slower growth, you may want to rethink about job security. How would you adapt if your company had layoffs because of a slower economy?

Something on a personal scale happens to you or a loved one and you don’t have the insurance to cover it. I know… you can get a bazillion types of insurance, and, lucky you, whatever happens is not covered.

You don’t have the money at the end of the week. This is often the case. It is easy to build a life around what you make. Try building a life around only what you really, really need.

Your belief system wires you to be impenetrable to anything. “Nothing can happen to me” or “I make too much money to worry about that stuff.” That is a huge risk to take. Look at those around you and imagine who you know that is having a tough time “making it.” If it can happen to them, it can certainly happen to you.

So what if I start to save, how much should I save?

Many personal finance “experts” want you to save 6 months salary after taxes. If you are making $60,000 and you are in the 30% tax bracket, you should be saving:

$60,000 x .30 = $18,000 - $60,000 = $42,000 / 12 months = $3,500 per month

$3,500 x 6 months = $21,000

Do you know how long it will take putting in $200 a month in a 3% savings account?

7 years, 10 months

Ridiculous, huh!?! Now, you understand why no one wants to save for an emergency account. But that doesn’t mean we shouldn’t do this, especially for the reasons I mentioned above. We just have to be “more creative” about how much we would need in an emergency.

Solution: A financial emergency plan

To do this, we are going to create a financial emergency plan, just like those fire drills you had in grade school. Our objective is to accomplish a more realistic figure that would reflect tighter spending habits in a thrifty environment:

Step 1: Take 10 minutes and pull out your last 2-3 financial statements for all your accounts, including credit card, bank and/or brokerage statements – anywhere you have expenses.

Step 2: Look at each and every expense. Determine which ones are essential and which ones are less than essential if you were stuck in an income emergency situation (buying “Tickle Me Elmo” is not an emergency).

Step 3: Calculate all your “essential” expenses. And presto, this is the true monthly figure you should save for. So if you have been living off of that $3500 after tax figure, you can now reduce that number to $2800 in an emergency (via eating out less, looking at my prior post for more ideas on savings, etc).

Now, go back to our savings calculator and put in the total savings we need in the case of an emergency:

$2,800 x 6 months = $16,800, of which we would be able to shave off a year on a half, but six and ½ years is still a long time.

Thinking outside your box

Tell you what, let’s be even “more realistic” and say “If I need to, I can supplement most of my income with a part time job or temp work after 3 months, until I can turn things around.” Let’s now do the calculation for 3 months.

$2,800 x 3 months = $8,400, which we would only have to save for 3 years and 4 months, which isn’t long considering most of us work 30-40 years.

Not bad! We have now saved enough to cover our expenses for a short time. And by having an emergency savings account, you don’t need to touch your retirement account. So when you eventually get an income back, you don’t lose the continued growth in your retirement portfolio.

Fixing the other side of the equation

Remember, an emergency account is for temporary emergencies. If you are facing or expect to face a genuine long term emergency, then you will need to consider tapping your 401(k) and focus on improving your income.

I highly recommend picking up a copy of What Color is Your Parachute. This book helps to quickly and efficiently identify ways to get your income back on track. Don’t waste your time with traditional routes if they don’t seem to immediately work.

Also, don’t be afraid or too proud to seek assistance from others. I remember one of my friends, who has Type I Diabetes. I begged her for years to seek help through a government program. When she finally caved in, she found the care she received was no different than before. Unfortunately, she spent a bundle on medical expenses before getting to that point. Sometimes we just need help from others.

Where do I begin?

You can start by saving a small amount, like $200 a month, directly deposited into a savings account at a different bank than you currently use, so you are not tempted to use the money in non-emergency situations (out of sight, out of mind!).

This account should be set up so your monthly contribution is transacted automatically at the time you get paid. If you can’t budget $200 a month to start, arrange a smaller amount of $50 a month and, in the mean time, look to cut unnecessary expenses until you are able to contribute more. Sometimes, actively heading into the right direction is powerful enough to make a long term difference in your life.

You may want to use a financial comparison site, like Bank Rate, to determine the best rates for CDs and Savings accounts. A higher rate can shave months off your emergency fund.

Finally, start today. Don’t wait. Get your bank statements out, and make it happen. The sooner you get there, the sooner you enjoy a bit more economic security.

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