Debt is a viscous cycle. This is especially true if you have a lot of debt. Focusing on paying off debt is key to ending the cycle. However, if a new, surprise expense pops up out of no-where what can you do, other than pay for it with credit?
If you’re up to your eyeballs in debt, it is hard to see how to get out. Staying focused, having a plan, and consistently chipping away at the debt will make it eventually fizzle to zero.
The Importance of an Emergency Fund
Your emergency fund is a tool that you can use to avoid getting into debt and gathering more debt. Debt is the enemy of those pursuing financial independence as it prevents you from maximizing your savings rate.
Think of your e-fund as a tool with a singular purpose, and only this purpose- debt prevention.
Do not use your e-fund for superfluous purchases, like getting the newest phone because last year’s model is now too old or upgrading your car because you saw one that was shinier.
Emergency expenses are any expenses that are unplanned and you had no foresight to set aside cash to pay it. E.g. a flat tire, unplanned car maintenance, unplanned medical expense, your laptop that you use for work was stolen, losing your job, etc – you get the idea.
If you are in debt, you need to know your debts, make a list and make a plan to pay them off. Don’t include your mortgage in this list since mortgage interest rates are at all time lows.
Depending on your situation and goals, I recommend the following e-fund amounts:
- You are currently in debt
- Save $2,000 or 1-2 months of expenses (whichever is greater)
- Do not add any other debts. If an emergency expense comes up, use your e-fund to pay for it. Then rebuild your e-fund.
- Focus all of your extra income into paying off the debt
- You have no debt (besides a mortgage) and are on the way to financial independence
- Save 6-12 months of expenses
- Do not add any debts
- You can use credit cards to gather points and cash-back, however be sure to pay them off completely each month to avoid interest.
- You have debt and are financially independence
- Save 6-18 months of expenses
- Do not add any other debts. If an emergency expense comes up, use your e-fund to pay for it. Then rebuild your e-fund.
- Focus on paying off the debt
- You have no debt (besides a mortgage) and are financially independence
- Save 12-24 months of expenses – (I recommend a larger e-fund when you are FI so that you can avoid drawing down on your investments when there is a market downturn/bear-market)
- Do not add any debts
- You can use credit cards to gather points and cash-back, however be sure to pay them off completely each month to avoid interest.
These are my recommendations, choose whatever e-fund amount you feel comfortable and confident with.
Mrs. FFR and I are on the long road to FI, and we currently have an e-fund of around 8 months of expenses. We have student loan debt (0% interest currently due to the CARES ACT), that we will pay off before 2021. Once we pay this, it will bring our e-fund down to 5-6 months of expenses.
Once we’re debt free, we will build our e-fund up to 10-12 months of expenses. When we’re FI, we’re planning on keeping 18-24 months of expenses in a combination of HYSA and CDs.
Financial Free Runner 