Here's How Much Ramit Sethi Says You Should Have in Emergency Savings
There's no shame in starting from scratch to build an emergency savings fund.
- The global pandemic showed us how important an emergency fund can be.
- It's okay to build an emergency fund a little at a time.
Bestselling author, blogger, and speaker Ramit Sethi now recommends aiming for 12 months' worth of expenses in your emergency savings account. This is a departure for Sethi, who previously recommended saving three to six months of expenses.
Why the change?
As the pandemic has so dramatically illustrated, life can change on a dime. Business owners who were financially secure suddenly found themselves shuttering their businesses. Longtime employees found themselves jobless. And healthy people ended up with an illness without a predictable outcome.
And while we've watched interest rates drop and housing prices skyrocket during the pandemic, the opposite has also been known to happen -- interest rates do rise, and housing prices do drop. In short, life is unpredictable. Even if you never need your emergency fund, Sethi says it's vital to have one.
Why build an emergency fund?
Sethi makes an interesting point on his blog, I Will Teach You To Be Rich. In 2015, five years before the pandemic, 10% of Americans took a "hardship withdrawal" from a 401(k). In addition to the penalties levied for early withdrawal, these folks also lost out on how much their accounts would have grown during that time. In short, even without a pandemic, emergencies can and do arise.
Another point Sethi makes is that an emergency fund allows you to be more aggressive as you make financial decisions, including how to invest and whether to start a business. Knowing you have funds put away for a rainy day allows you to make decisions knowing you have a way to cover bills if anything goes south.
Saving is difficult for many Americans, and if you live on a tight budget, putting money away for a rainy day can be daunting. Sethi -- author of I Will Teach You To Be Rich -- tells his readers not to worry. You can create an emergency fund starting from wherever you are today.
Sethi says it could take a while to figure out how much you can afford to put away each month. He uses the example of someone whose expenses run $1,000 a month, who can only put $50 into an emergency fund. It will take that person 10 years to save six months' worth of expenses.
Here's the thing: That's okay. Moving in the right direction is better than not moving at all.
In the meantime, it pays to find ways to add to your income. Not only will it increase the speed at which you can save it will give you more breathing room when you pay bills each month.
Sethi's abbreviated four-step savings plan
Keep in mind that this is a tightly abbreviated version of Sethi's suggestions for saving:
Step 1: Figure out how much you need to save
Add up how much you spend on monthly bills, multiply by 12, and you have a goal to aim for. Keep in mind that it's going to take time to reach that goal. Do not get discouraged.
Tip: Our emergency savings calculator can help you come up with a savings goal.
Step 2: Open a separate account
Opening an account to hold only emergency funds can help you resist temptation if you get the urge to dip into it. Do not commingle emergency funds with money for everyday expenses.
Step 3: Automate savings
Let's say you bring home $4,000 per month and want to put $200 into your emergency account. As long as your emergency savings account is linked to your regular checking account, you can set up an automatic transfer. For example, if you're paid twice a month, set the transfer up to automatically move $100 from each paycheck into savings.
There are a couple of advantages associated with automatically transferring money into savings. The first is that it makes it easy to save, because you just set it and forget it. The other is that it reduces the self-discipline typically involved in saving money.
Step 4: Create more income
There are many ways to create more income each month. And even if the new revenue streams are small, they still speed up the rate at which you build savings. They include things like:
- Cut back on unnecessary expenses, particularly those you don't use or especially enjoy (an old gym membership, premium channel you rarely watch, or subscription service you're no longer interested in).
- Take on a side hustle that's fun for you. For example, if you play an instrument or speak a foreign language, you can offer a tutoring service to those who wish to learn the skill. If you're crafty, sell your wares online or at craft shows.
- Start your own business. Even if you start off slow while still working a 9-to-5 job, there's no time like the present to create your own dream job.
While Sethi is known for his blunt style, he always shares information with a huge dose of heart. He continually reminds readers not to beat themselves up. Instead, he says, use that energy to come up with creative ways to make life better.
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