Virtually every personal finance advisor has one rule: Make sure you have an emergency fund. This is especially true for people who are starting to get their finances in order for the first time.
An “emergency cushion,” as it is so aptly named, is meant to stop you from dipping into your savings account in the event of unforeseen emergencies: being laid off, unexpected medical bills or a random accident.
The majority of Americans have less than $1,000 in their savings account. As one might expect, this can cause major problems when unexpected bills arrive. For those who don't have savings for emergencies set aside, the temptation is to pay for unexpected bills with credit cards. For those who are unprepared, this can begin or perpetuate a credit card debt cycle. It is better to be prepared for the inevitable emergencies because, well, they happen.
Building up a $1,000 emergency fund should be your first step in planning for the unexpected. This step-by-step guide will help you get to your emergency savings goal one step at a time.
1. Analyze Your Spending
One of the main reasons for a lack of savings is overspending. Take out your credit card bills and print out your bank statements from last month. Categorize how much you spent on these areas: eating out, clothes, nights out with friends and travel.
As the British economist Tim Jackson says, “We spend money we don't have, on things we don't need, to make impressions that don't matter.”
Analyze how much you actually spend each month on things "that don't matter." It might make you change your outlook on your spending.
2. Create A Budget
Once you have taken a hard look at your spending, the next step is to create a budget. Add up all of your revenue streams throughout the month and subtract everything from step one. Where did you land, positive or negative?
The budget creation process is a terrific way to look at your finances on a cursory level view and gain a snapshot of what is happening on a monthly basis. Plan out your next month, and find areas of weakness that you want to fix. Can you cut a couple nights out with friends? Perhaps, try cooking in a couple nights a week? There are always weak areas in the budget, you just have to find them.
3. Set A Goal
Goal setting is psychologically one of the best ways to achieve success. Write down how much you want to save in the first month. An important point here is to be realistic with your goals. For example, if you don't have an emergency fund, try and begin with a monthly savings goal of $50.
I know it doesn't sound like much, but if you do that for a year, you end up with $600. Not bad.
4. Pay Yourself First
We are conditioned to think everyone else should be paid first: the bank, the credit card company and the landlord. As a result, it seems like we end up with a meager portion of our income left over to actually enjoy. Breaking this payment cycle is the key to savings success, and it starts with being a little selfish.
Instead of paying the bank or credit card companies first, pay yourself first. You are the one going to work every day and showing up, succeeding and earning that paycheck. Give yourself a reward every time cash hits your bank and allocate some to your emergency fund account. Then pay everybody else.
5. Automate Your Payments
After the momentum of savings for an emergency fund builds, it's time to automate the savings process. Automating your finances is not time consuming and produces optimal results. Out of sight, out of mind truly pays in personal finance.
If you can schedule an automatic transfer from your checking account to your emergency fund for the first of the month, or the same day that you get paid, it will take the headache out of physically having to perform the transfer yourself. The removal of this affirmative step, or making the decisions to move money, streamlines the process of savings. Automate your finances for optimal results.
6. Unexpected Money Goes Into Savings
Did you earn a bonus? Any unexpected money should go directly into your savings account. It might be nice to visualize what you could purchase with your newfound cash, but leave it for the daydreams. Your life will not be altered by your unexpected wealth, but perhaps it will transform your savings account. Defer to the future what you were going to buy today.
Inevitably, good things happen all of the time. It is important to acknowledge and celebrate your successes. Creating an emergency fund shows a sign of maturity and forethought. Once you reach your goal of a $1,000, make sure you enjoy that accomplishment and go do something fun.
Saving for the unexpected is not the sexiest thing to do with your money, but staying financially fit will prove useful later down the road. It will be in the moment of need that you see the true value in your emergency fund. A good decision today creates a better future for tomorrow.
This post was originally published on the author's personal blog.