What Comes First? A Step By Step Guide to Financial Independence. Step 1: Set Up an Emergency Fund
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Many college graduates find themselves in a very interesting, exciting, but sometimes overwhelming situation: they are actually making money. For the first time in their lives, money is coming in that is not going straight back to tuition. While this is definitely a good thing, it often leaves the new graduate wondering what in the world to do with the money. Should they invest it? Should they pay off their student loan, automobile, or house debt? Or, should they buy fancy new items with it?
In this series, I am going to present a step by step guide to financial independence. Basically, you can consider this a what-to-do-with-your-money-once-you-start-making-it guide. I must admit that the inspiration for this series comes from Dave Ramsey’s “Baby Steps” in his “Total Money Makeover” book. Although the steps in my series will be similar to his Baby Steps, there will be some small modifications. With that out of the way, let’s look at Step 1: Set Up an Emergency Fund.
Step 1: Set Up an Emergency Fund
An emergency fund is arguably the most crucial necessity for financial independence. Having one puts YOU in control–not your wallet. Setting up an emergency fund is probably the most important financial thing you can do to lower your stress level, strengthen family relations, and raise your confidence.
What is an emergency fund? An emergency fund is an amount of money that is set aside to be used only in the case of an emergency. An emergency, in this instance, can be broadened out to include any unexpected necessary expense. For example, your emergency fund might be used to pay for unexpected car repairs, house repairs, or medical bills. Your emergency fund may also be used in the event that you lose your job and temporarily do not have a source of income.
How much should you put in your emergency fund? For the purposes of this step-by-step guide, a good starting point for your emergency fund would be either $1000 or 1 month’s worth of expenses, whichever is higher. Dave Ramsey recommends $1000 as the starting point, but I personally believe that anything less than 1-month’s worth of expenses is too little to move on to Part 2. Eventually, you will want to raise your emergency fund to 6-8 months’ worth of expenses. This recommendation has been raised from what it used to be. Traditionally, financial experts have recommended 3-6 months’ worth of expenses in an emergency fund. In today’s economy, however, it is not unusual for a person to be unemployed for 8 months or more. Because of this, it is not a bad idea to have an emergency fund with 8 months’ worth of expenses.
Where should you put your emergency fund? There are many different places where you can put your emergency fund. Wherever you choose, make sure the place is neither too easily or too difficultly accessible and safe. For specific recommendations, see my article Where to Put Your Emergency Fund.
With your $1000 or 1 month emergency fund in place, you are now ready to move on to Step 2! Check in tomorrow to find out what it is!
Do you have any advice for emergency funds? Make sure you let us know!
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