Financial emergencies can strike at any time, and being prepared for them ahead of time can reduce the stress you feel when one happens. But only having an emergency fund is not enough. Create a financial emergency plan to back it up. That plan is your roadmap for how you’ll spend from your fund and pay it back after life returns to normal. With these two things in place, you’ll find that you have less to worry about when you encounter a tough situation like job loss or an extremely large medical bill.
In this article, we’ll walk you through some simple steps to help you create your plan.
1. Create a lean version of your budget
By ‘lean’ we mean creating a budget that cuts out all of the unnecessary stuff. Things like fun and entertainment won’t be a priority when you need to cut back on spending. To get started on your plan, create an emergency budget template that lists out your spending only for necessary items, like food, rent or mortgage, transportation, and healthcare. You can revert back to your regular budget when your income returns to normal, or after you’ve paid off any debt you take on. You can see more details for creating your lean budget here.
2. Define what “emergency” means for you
Defining which situations call for an emergency response is important. Are your emergency fund and plan there in case you lose a job? Or will you try to cut back spending when you receive a hefty medical bill that you need to pay off quickly? You might also turn to your emergency plan if there’s a death in the family. Deciding this ahead of time will help you know what to do in the moment. Then, if there’s something smaller going on, you’ll know to look in your other envelopes or save up, rather than draw from your emergency fund. Because, let’s face it — those spiffy shoes you’ve been eyeing or the unexpected expenses while you’re on vacation aren’t a true emergency. You can save up for those or skip them altogether. Even a flat tire on your car is something you’d pay for from your ‘car repairs’ envelope — all cars break down at some point, so we can expect car repairs and plan to save regularly for them.
Defining “emergency” for yourself also helps you know how much you should start saving in your emergency fund. If you’ve defined your emergency as a job loss, then you might consider saving up an emergency fund that has about three months worth of expenses in it. If your emergency is covering an unexpected large medical bill, than you might choose to save more or less.
3. Start saving now
By reflecting on the two steps above, you should have a rough estimate on how much you’d like to set aside for an emergency. Once you have that number in mind, you might need to reconfigure your budget so that you can start putting money in that fund as soon as possible. You can use a Goal Envelope to start saving. Give the Envelope a due date for when you’d like to have 100% of your fund saved up, and Goodbudget will help you set aside the right amount from each paycheck.
4. Have a plan for how you’ll pay everything back
Your plan should include details for how you’ll replenish your emergency fund, or pay back any debt you take on, after the emergency ends. That might mean you can’t go back to your regular spending habits immediately after the emergency is over. Only after you’ve built up your savings again, or paid off your debt, should you return to your regular budget.
This might sound like a lot of work. But, we think the peace of mind is worth the effort to be prepared for all of life’s twists and turns.
– The Goodbudget Team
P.S. Coming soon! Pay off debt with a budget that works using Debt Accounts on the web. Stay tuned for more about these features.