One of the first lessons that I teach in my book, The Confident Investor, is that you need to have an Emergency Savings fund to tide you over when bad things happen to you and those you love.
Every investor should put 10% of your earnings into a savings account at the bank immediately, preferably before you even touch your wages. Most employers now offer automatic deposit of your check into as many bank accounts as you wish. Set up your direct deposit so that 10% of your earnings goes into a different account to that in which you normally keep your money. Do not touch that account to pay the bills unless calamity has beset you or your family. This is the cushion to keep you financially secure.
That savings account needs to build up to the equivalent of six months of your after-savings and charity income to help you in case life deals you a tough hand, such as:
- If you lose your job.
- If someone in your family is diagnosed with a medical condition.
- If some catastrophe happens to you or someone you care about.
You will need those 6 months of income to give you a soft landing while you put your life back together.
If you have nothing saved right now, simple math tells you that it will take you 48 months to save up this cushion. The interest does not count here since the interest on a savings account will barely keep up with inflation.
Once you have accomplished that minimum goal, then you can begin to invest.
To calculate how long you need to generate this savings, let’s do a simple example. Assume that your after-tax income is $50,000 per year. You will want to have 6 months or half that annual number in cash savings. In this example, that is $25,000. If you have no savings today, you will need to be diligent about building up that cash. It won’t be easy but nothing worthwhile is easy. If you save 10% of your after-tax income to that savings account then you will put $5,000 per year into that account. It will take you 5 years of saving $5,000 per year to accumulate $25,000.
Your should only start investing money in the stock market after you have built up your emergency savings to a 6-month cushion. Once you have that cushion, you will be very comfortable in your life as you know that you can weather any major calamity that befalls you. You will be able to redirect that 10% savings to your investment fund after you have built up your Emergency Savings fund. That 10% will be the money that you will use to invest in the stock market using the tools that you learn in my book, The Confident Investor.
If you already have some money in savings, you will hit the goal of 6 months even faster. If you have purchased my book, The Confident Investor and registered on this site you can download a worksheet that will help you with this calculation. I am sorry but this worksheet is only available for registered readers of my book (it is free to register once you have the book).
The worksheet is available here.
Note to readers of book. There is an error in the book that missed editorial review. It takes 60 months to save for a 6-month Emergency Fund if you have nothing set aside and you are only saving 10% of your income. In the book, I erroneously put 48 months. I apologize for the error. This error will be corrected in the 2nd edition of the book.