Save what you can toward the emergency and life happens fund. But don’t worry yourself sick at the slow growth. The point is it’s growing even it’s just one dollar at at time. — Michelle Singletary

CREATE AN EMERGENCY FUND

As far back as in 1561, an Italian playwright wrote a comedy La Spiritata which had the phrase “save for a rainy day”. To save for a rainy day means putting aside money to tackle the inevitable emergencies that come upon you. For example:

  • You lose your job and need a few months to post resumes, look for job listings, go out on multiple rounds of interviews etc
  • You dear old car finally gave out on that maintenance you have been postponing and now you need to spend hundred’s of dollars trying to get it back on the road
  • A near and dear family member has a sudden illness or accident with large medical bills
  • A storm caused severe damage to your roof which is now leaking
  • …. the list goes on and on.

All of life is a game of probabilities. There is a large chance that any particular one among the above mishaps might not happen to you, but there is a very small chance that none of the above will happen to you at the time you least expect it.

56% of Americans can’t cover a $1,000 emergency expense with savingsBankrate survey 2022

Before you even think about investing towards financial independence. you need to focus on building up an emergency fund that will give you 3-6 months of living expenses. This is just to account for the unexpected events of life. If for example, you lose your job, your emergency savings need to be able to support you until you find a new one.

To come up with an amount needed for a barebones emergency fund, you look at your monthly expenses and cut out what’s not absolutely essential (perhaps the weekly dinner and movie nights) and keep only the essentials (mortgage, utilities, food, etc). Once you have a basic number, multiply that by 3 and that is your minimum emergency fund size.

The emergency fund should not be in illiquid investments (such as real estate) or volatile investments (like stocks or bonds). This is because at the time you need it most, it’s possible that these investments can not be withdrawn from fast enough. They might also be temporarily down. Being forced to sell your investments in a hurry when they are low will not only give you a low price for them, but also set back your plans for financial independence.

The best vehicle is usually a bank savings account or a money market account where you are able to get access to the money within a day with no penalties. Once your emergency fund is set, you can now start investing in stocks.