If you’re living paycheck to paycheck, you are basically a slave to your job. You are beholden to the whims of your company and the vagaries of the economy. These are things that you cannot control, and so there is no reason to complain about them. Fight for your freedom, instead. Focus like a laser on what you can control: build an emergency fund, the first step towards financial independence. The sooner you can start saving, the better.
What Is An Emergency Fund?
Like it’s name suggests, an Emergency Fund is enough savings to handle typical emergencies: a layoff or other loss of work. Medical bills, a roof leak, a car accident. It’s typically thought of as 3-6 months of your living expenses, or perhaps up to 1 year. If you do not have enough money to cover these types of “normal” emergencies, you need to get on that asap! Quit shopping, and start saving!
Now, I know many people are living paycheck to paycheck. It’s a struggle, for sure. Unfortunately, this situation makes you completely beholden to your boss and to your job. If you value your freedom, your top priority absolutely needs to be to build a an Emergency Fund. This is more important than paying off debt, and certainly more important than going out with your friends or getting the latest iPhone. If you believe your job is safe, you’re wrong.
What To Do With Your Emergency Fund
In short, do nothing. Most financial advisers will tell you to to keep your Emergency Fund liquid – in a checking or savings account, where it won’t earn much return, but it also is safe, and won’t lose value. More importantly, DO NOT TOUCH IT, unless you truly have an emergency. Your Emergency Fund is not a friend that loans you money to make a car payment. Your Emergency Fund does not buy you tickets to a show. And your Emergency Fund certainly does not think you should buy that jacket.
When you first build an Emergency Fund, when you have no other savings whatsoever, I agree that you should keep it in a liquid savings account. But, this is bad advice if you are well on your road to financial independence. You need your money to work for you if you want to retire early. And the only way to do this is to invest as much as you comfortably can into productive assets: stocks, bonds, real estate. You do not need a whole year worth of living expenses twiddling it’s thumbs in a savings account. You are losing money if you do that.
I target about $20,000 in my cash accounts. This is way more than enough to cover a few months of expenses, and it can pay for most emergencies, such as my son’s surgery this year. In the event that I lose my job, or have a larger emergency, it won’t take long to liquidate some stocks and bonds. I probably have too much in cash, but it makes me feel that I don’t have to be constantly watching my checking account. Any more than this, and I am walking away from easy money.
The Three Degrees of Financial Freedom
An Emergency Fund is just the first step towards achieving financial independence.
Once you build your Emergency Fund, don’t stop saving. An Emergency Fund does not in any way give you complete freedom to do what you wish. You are no longer living paycheck to paycheck, but you still have very limited options. Keep saving, the more the better.
Beyond your Emergency Fund, once you’ve saved a few years worth of expenses, then you have what’s known as F.U. Money, the second degree of financial freedom. With FU Money, you have the freedom to tell your boss to go to hell (perhaps in stronger words) – it is the freedom to have a completely fresh start.
Finally, after 10-15 years of hard-core savings, you can achieve Financial Independence – generally considered to be 25x your annual expenses. Want to learn more about the easiest, most straight-forward path to early retirement? Start Here.