Welcome to building the lifeboat. But before we get there, its time to start with a bit of a paradox. And that is that while I have a roadmap, this step may not be in exctly the right place for you and your journey. Let me explain….
For some people, when you are managing debt you need to be able to make sure you don’t get into debt again, but at the same time managing the debt you have. There is nothing worse than paying down debt, feeling you are making progress, and then having an emergency that plunges you right back to where you started. It’s like a kick in the balls. And that’s what an emergency fund is for – an emergency. It’s money that stops you from going into problem debt. It doesn’t have to be huge, every little helps, but we have a long-term aim for this, which is in step 7.
Debt or Emergency?
So for some people, this stage happens AT THE SAME TIME as paying down debt – you pay some debt, you save a bit as well. I am a big advocate for doing that. BIG advocate. I don’t want you to have worked your ass off for months slogging away to get rid of problem debt, just have a random event put you back. Honestly, it’s soul-destroying. So our basic plan is to manage both at the same time, and that means steps 5&6 overlap a bit.
For others, it’s a step-by-step process and you will do this before the debt payback plan kicks in. That’s fine as well. You will still need to manage the debt, so make sure you read the next step as well.
Whichever route you are taking, this money is critical both for your financial security and your peace of mind. Imagine not having to worry about that bit of financial chaos that enters your life (kids don’t count. No emergency fund covers THAT chaos). As I may have mentioned, it’s for emergencies, and those little buggers have a habit of popping up in life. Boiler problems, flat tyes, kids breaking windows, kettle blows up (no tea, WHAT?). These things happen, so we have to be able to live with them and deal with them. An emergency fund is your lifeboat that you launch in times of trouble, and writing this as the UK starts to come out of the covid crisis, we have all had experience of that!
Now, if you are following the roadmap, this is just a starter emergency fund – you will see it gets a bit bigger in step 7. That’s because there are scales of emergencies. And we want to be fully grown adults when it comes to money, so it gets bigger later.
And it’s a really simple thing to do in theory. You open an account. You save money into that account every month. You get to £1,000 and you are there. Simples. There are a couple of nuances though…
- I always suggest this is money that should be kept away from your normal current/checking account. Open another one. It’s nice if it pays a bit of interest, but it’s not critical. You really just need somewhere to keep the money and hopefully never need it.
- Access is important. You need to be able to get to it quickly. The boiler has broken, you have no heating or hot water. You need to be able to get someone in now and pay them.
- A credit card is not an emergency fund. Yes, it works a bit like one – access to quick money to pay an emergency bill, but it’s doing it with debt and not cash. If you have the money in the bank to pay the credit card bill, then using the card to pay is fine, just make sure the £1,000 is there to cover the bill when it comes.
How this ties into paying down your debt is critical – debt is very likely costing you a load of interest, so we want rid of that. But we want to start the process of getting the emergency fund in place, so I would prefer you to do both at the same time.
How I would do it
In the next step I will explain the different debt strategies in detail, so have a look at that for how to do those. But if I was managing both I would do it like this, and its spreadsheet or pencil and paper time again….
- Collect information on the debts I have. Credit card, loans, car payments, store finance etc etc. Make a list of them all. Take a minute to look at them all. And maybe get that cup of tea – this can be a horrible thing to see for the first time.
- See what the minimum payments are on each. Write them down against each of the debts. Add up the total. Maybe more tea? It’s tough.
- Look at my budget to see what I have spare from my income each month. If there isn’t any spare, then we have a debt problem to manage and you should jump to the next post and we will work that out. If you are unable to service your debts, you are probably already in an emergency that we need to manage now. See Step 2 of the plan.
- Where you have spare money, allocate it to the minimum payments on each debt, and work out how much is left after that. Remember step 2 when we set up to service our debts? Well…….you should already be doing this before getting here!
- This is now your “spare money”. But remember the budget had “fun money” in there? This may be time to make some tough choices about what is fun and what is a necessity for the financial journey.
- Now we have to split it between debt and emergency fund creation. and annoyingly, there is no right answer for a way to split it. When I looked at this personally, I went after debt HARD, 90% to debt, 10% to the emergency fund. And then as debt came down I moved more towards the emergency fund. I suggest you start with a 75/25 split in favor of debt. Debt is guaranteed to hurt you, and even a modest emergency fund can help IF you need it. It’s going to depend entirely on how much you have spare, and which gives you sleepless nights – the weight of the debt or the fear of the emergency? BUT absolutely we need to make sure we are paying more than the minimum on the debt, or it just goes on forever. See the next step for how we will do this.
Thats kind of it – keep going and keeping checking, getting up to that £1,000. For some it takes months, for others it can take a couple of years.
But just remember, when you have this step sorted, along with free money being invested, you are making progress, not drowning. The next step is paying debts off, and once that is sorted, you are 100% all about progress!!!!!