An emergency fund is one of the pillars of personal finance. Having a sizeable emergency fund might secure your financial future and safeguard against financial crisis. Emergency fund shields you from borrowing money at a high interest. For example, a $10,000 unforeseen medical expense, if paid with a borrowed money, will require you to pay almost $20,000 over the years, including interest charges. That’s a lot of money. If you have $10,000 saved in an emergency fund, you can pay without borrowing the money.
One big problem is people understand the benefits of having an emergency fund but to actually build one when you’re barely scraping by seems like a daydream. Building emergency fund from scratch is a hard task. Let us talk about a few tricks on budgeting your money to actually build an emergency fund without having a big income.
Why it is hard to create an emergency fund with a low-income
When you are barely saving or rather, surviving paycheck to paycheck. Saving a part of your income is a dream, a near impossible ask. If you set a target of saving $300 a month, there will be some months where you’ll actually have to draw money from the saving kitty, let alone contributing $300 in that month. Our expenses vary due to unforeseen events.
(Also read – Retirement saving for low-income earners)
Often it happened with me that whenever I aimed to save more some unusual expenditure occurred that derailed my plan. Be it a traffic ticket or relatives visiting. Saving $300 or $200 every month with a low-income is not an easy job.
The money set aside for tomorrow’s emergencies can be required to meet today’s need.
If progress to build the emergency kitty is slow or stagnant in the beginning, it can send a negative signal. It can affect our psychology and may turn us against the sustained effort. I always talk about taking financial hard stands only after ensuring proper rewards after achieving every smaller goal. Rewards keep us motivated.
If we fail to meet monthly saving goal repeatedly we may lose hope that we’ll ever be able to build the fund and free ourselves from financial struggles. We need to find some other way to go on, that may let you save lesser but it should not let you fail, ever.
surprisingly, there’s one way I would like to discuss today.
Creating emergency fund with low-income
Every success in personal finance happens slowly. You can’t really be in a sound financial position overnight unless you win a lottery. You can’t be debt free all of a sudden. You have to pay off your debt slowly and steadily to become debt free. This is called “snowballing.” Starts small and eventually, it gets bigger and bigger.
In the case of emergency funds also, you can’t build a sizeable fund overnight. And when you have a low-income, it becomes very challenging to build as well.
So don’t target to save $300 a month. Instead, simply make a list of all of your expenses. Many of these will be variable such as gas, electricity, groceries, health, etc. Now, instead of budgeting the average amount each month, budget the maximum you might expect to pay in a month.
Rather, make a list of all of your expenses. Think of all the categories, like grocery, health care, gas, cable bill, cell phone, etc. Most of the categories have variable expenses. Grocery bill, electricity bill or gas expenses vary each month. variable such as gas, electricity, groceries, health, etc. Now, instead of budgeting the average amount each month, budget the maximum you might expect to pay in a month.
As a rule of thumb, we average the expenses while budgeting for a given month. Now stop allocating an average amount in a variable expense category. You start allocating the maximum expense you had in last 12 month. If in January your electricity bill was $160, do allocate $160 every month. In summer when you get lesser bills, you’ll have more surplus.
Another example: Say that you have a 15-gallon car that you fill up thrice a month (with the gas price of $2 a gallon today) Assume that gas prices are still $4 a gallon. So instead of budgeting $90 a month, you budget $180 a month for gas.
Now, what’s the difference?
There’s a catch in this style. You should really train your mind that having a budget of $180 doesn’t really mean you can drive extra miles or you stop the car pooling if you were doing that.The extra budgeted amount is really for surplus and is not for increased spending.
The moment you master this budgeting style you will start saving for the emergency. How? Let see the next section.
Saving budget surplus in emergency fund
Now that you have surpluses on almost every expense types. put them away in saving accounts? Some online saving accounts do offer interest. Although today’s interest rate is very low, even a 1% return on your savings is not bad. Put it in savings, of course! Specifically, you want to “roll over” the difference between your over-estimated budget and what you actually spent.
Now another trick to try is having either multiple savings accounts, one for each expense category or trying some banks where they offer an envelope style savings account. Ally bank, I heard, offer such facility. You can create virtual envelopes with them and put in money to an individual envelope.
Let’s say you save $40 from grocery budget, you create an envelope for grocery and put $40 in it. Over the months, you’ll watch your envelopes grow (and account value as a whole).With this technique, you will always be ahead of your actual expenses. This amount that you have in the bank can be used as an emergency fund.
Now that you know how to build an emergency fund with a low-income, you’ll probably start with you savings journey soon and fulfil your financial dream of being debt free and having enough saving. Simply by over-budgeting and saving the surplus you will be saving money every month without having to really think about it.
Simply by budgeting more than required and saving the extra you can save money every month without having to really struggle for it.
Readers, what’s your opinion about this idea, let us know if it can help you reach one of the most important milestones of personal finance, building and funding an emergency fund.
Stefan - The Millennial Budget says
Emergency funds are so underutilized it is scary. I like how you say save the max of your average variable cost. That way there will always be enough funds set aside no matter what the cost is. Setting up a sizable emergency fund can take years but it is definitely a crucial part of financial planning.
I can’t agree more Stefan. Having an emergency fund is must for everybody. It’s this fund that can safeguard you against borrowing money in future.
Emmanuel M'M says
I am literally starting back from scratch after a few bad decisions and unforeseen circumstances knocked me down. But the plan works
All the best Emmanuel, someone said a win is a real win if it comes because of lessons learnt from a previous loss.