The average American cannot write a check today to cover a $600 emergency without having a devastating effect on their finances. This was the exact situation my wife and I were in years ago.
How does the average person living paycheck to paycheck manage to save three to six months of expenses for an emergency? That is a great question and I am glad you asked.
Let’s start by getting a better understanding of what that really looks like. Three to six months of living expenses is not the same as three to six months of salary, or even the amount you normally live on.
In an emergency, we would tighten the belt and we would only fund the basic necessities. Things like vacations, new clothes, dining out, etc. would have to wait.
Here are the steps that my wife and I used back in 2009, when we decided our financial life was a wreck.
All you need to make this work is self-discipline, an accountability partner and a budget.
Notice I did not say money. If I had said money, you would have stopped reading right there. Through this process I will show you where to get the money to make this all work.
Don’t worry. When we started this, we were living beyond paycheck to paycheck. If we could do it, I am confident you can too.
Start by making a list of all of the things you must spend money on each month. These expenses would fall under the category of basic needs and they are housing, utilities, groceries and transportation.
Then add the basic wants. These would be things like your cell phone, your cable, internet, etc. List these items in order of importance.
Lastly, list all of the things you currently spend money on, but could cut back on or eliminate. These are things like eating out, fancy $5.00 coffee and that gym membership you don’t ever use.
When my wife and I did this step, we realized that I was spending about $60 a week just going out to lunch with my co-workers. Prior to completing this list, I had no idea I was spending that much.
Reduce the fat
Eliminate or reduce 6 things from the list. It is your money, so I am not going to tell you what items to eliminate or reduce, but if you are golfing twice a week, I would recommend reducing your green’s fees before reducing your grocery budget. If you are married, you should do this together.
Now that you have done this, you should have found some money that you can reallocate towards your emergency saving account.
You will want to keep this money in a separate account from any other money to insure it does not accidentally get spent.
I don’t recommend keeping your emergency fund in your underwear drawer! Who knows who is pillaging through there? Just Kidding!
If you are like me, you might struggle with discipline a tiny bit. So you will need to keep the funds in a bank or credit union account that provides limited access, no ATM card and no online access.
This will help to detour you from spending it on emergency impostors like Girl Scout Cookies, pizza or a new vacuum cleaner. You have to watch those door to door sales people…They are good.
Create a plan
Create a monthly budget. Do this together with your spouse or significant other if you have one.
The budget we use is called a zero base budget. This means you spend every dollar on paper on purpose before the month begins.
This type of budgeting eliminates impulse buying, because if you did not budget for it you can’t buy it unless you re-do the budget.
You will include the monthly amount you have saved from step 2 in your monthly budget. This will be paid to an account just like you were paying a bill. Set it up on auto deduction and every time you get paid it will automatically be deposited into your account.
This will guarantee the funds make it into the emergency fund account and reduce the opportunity for those funds to get spent before you can get them deposited.
Accountability is key
Find an accountability partner, someone who will tell you no and not be afraid of upsetting you. Share your budget with them and ask them to hold you accountable.
It can be your spouse, but I don’t want to cause you to fight about money. So maybe it is best to select a neutral person that you and your spouse both trust and approve of.
It should go without saying, but you need to make sure the person you choose is good at handling their own financial matters. Your broke brother or bankrupt neighbor might not be a good choice.
The best way I know to prevent financial emergencies is to plan for them. I hope this article has offered you some real practical tips you can use to change your life. Please share it with friends and family who you think could benefit from this advice.