Everyone says you need an emergency fund. No one explains what that truly entails.
Are you tired of hearing the advice “make coffee at home” to save money? Yeah, me too. Actual financial growth is driven by a money vision powered by systems. Without those two things, cutting out small expenses won’t help you.
Here’s the system I use to find out how much I need in savings, and how I’m actually to save it.
Step One: Audit Your Expenses
If you’re anything like me, this will be the most painful step. However, it’s the most necessary.
I went through every credit card bill and bank transaction to calculate just how much my family was spending every month. I did this in an Excel sheet so I could apply formulas later. I wrote down every category of spend and what we were spending, like this:
Rent/Utilities: $1,400
Eating out: $200
Gym Membership: $25
It’s important that you don’t just guess, because we tend to guess that we spend less than we do. I know I did.
However, this step also showed me how much potential we had.
I created a formula to calculate my and my husband’s monthly income. I summed up the expenses, and found that we were making more than we were spending.
It was time to put that money to good use.
Step Two: Calculate How Much You Need
First, consider how many months of savings you’d like to have. Typical advice suggests 3-6 months. I like to err towards 6 months, but it’s a personal choice.
Take that number you have showing how much you spend each month, and multiply that by how many months of savings you want to have. I like to include everything I spend, not just mandatory expenses. Because if I have a medical emergency, that’s certainly not the time to make more food at home than usual.
You should now have four numbers:
- Everything you spend in a month
- How much you make in a month
- How much extra you do (or don’t) have leftover
- How much you need in savings to be safe
Step Three: Adjust Your Budget
Maybe you don’t have extra money at the end of the month, and you spend more than you make. Or maybe you just spend more than you’d like.
The first step is to cut expenses. Make sure you’re realistic here. You probably can’t go from eating out every day to making all your meals at home. The best way to control your spending is to plan it: allow some “fun” money, but keep it constrained.
If necessary, see where you can lower some of your bills. Check your phone plan to see if you use all the data you’re paying for. Switch your car insurance to a cheaper provider. If you’re really hemorrhaging money, maybe you need to move to a cheaper area. If you qualify, apply for assistance in government or charitable programs. There’s no shame in needing help. You’re putting in the work to build yourself back up, and that’s something to be proud of.
Finally, see if you can increase your income. If you’ve read this far and thinking that you’ve tried all of this and you still lose money, that’s pretty much your only option. You don’t have to get a second full-time job. Maybe you pet-sit for a week, take surveys, or start posting on social media.
After this, you should have your revised amount of money left over this month.
Step Four: Set Up an Automation
Last math problem, I promise! Divide the number of emergency savings you need by the amount you have leftover each month. This is how many months it’ll take you to build your emergency savings.
Now, automate it.
Set up a recurring transfer from your checking account to your savings account for the amount you have leftover. Don’t convince yourself that it should sit in a checking account. That’s an easy way to trick your mind into thinking that’s money you can spend.
Step Five: Invest
Congratulations! You’ve made successfully built your emergency savings.
But what should you do with all the money that was going towards your emergency fund?
If you’ve been in the finance world for any amount of time, you’ll know what I’m about to say: invest it. 😉
Set a new goal for yourself! Max out your 401(k). Pay off your mortgage early. Start a business. The sky’s the limit, and you have the system to reach it.