One of my major goals in life is financial freedom. For me, this doesn’t mean having a lot of money. Financial freedom simply means I’m secure enough financially that I don’t need to worry about having money.
Setting up an emergency fund with at least one year of income is a big part of this. I haven’t reached it yet, but thanks to some great resources on the topic, I’ve got a strategy in place that should help me reach this goal in 3-4 years.
Why One Year of Income in Savings?
It’s important to have extra savings to cover unexpected events. It’s also important to save for retirement. But those aren’t my main objectives in creating one year of income in savings.
My purpose for starting an emergency fund is simple: with it, I can go for one year without earning a dime.
If you’re living paycheck to paycheck, you don’t have significant flexibility in changing your career or business. Even if you wanted to make a switch, you’re completely dependent on your current income streams to support you. With an emergency fund, you have an entire year to transition from one work direction to another.
Why is Having Transition Time Important?
I love running this business. I can easily foresee myself growing it into a healthy full-time income and operating it for decades to come. But without at least an emergency fund in savings, I will rely on it to support me.
Without a reasonable escape route, I’m no longer working on this business because I love to, but because I need it to survive. It may be a luxurious prison, but it is still a prison. Financial freedom means that money shouldn’t be the driving force in my decision-making. An ambitious goal, but it can be one step closer with an entire year in savings.
Even if you have no intention of leaving your current path, an emergency fund can give you greater confidence in what you’re doing. Every business activity or job will eventually create conflicts between your professional mission and your need for income. For myself, this could potentially mean writing articles or recommending products I don’t fully agree with, just because they will earn money. Having an emergency fund gives me the ability to focus on a mission, instead of just profitability.
Financial Freedom Instead of Being Rich
Wealth and financial freedom are completely different things. Although it would be nice to be rich, I have no real desire for extreme material wealth in itself. However, financial freedom is an attractive goal for me.
Being rich means having a lot of money. However, if your costs are close to your income, you’re no more free than someone earning minimum wage. If your income was suddenly removed, you’d have to make huge personal changes or go bankrupt.
Profit is income minus expenses. If you’re spending close to what you earn, you may have a more comfortable lifestyle, but you haven’t gained any freedom. While I would argue that financial freedom is as much a mental goal as it is a material one, it is distinctly different from being wealthy.
Establishing an emergency fund with an entire year of income isn’t about the amount of money. For one lifestyle, that fund could be $250,000. For another it might be $15,000. Freedom isn’t a dollar amount.
How I’m Setting Up an Emergency Fund
My first goal for an emergency fund is $20,000 in savings. Because of my record keeping, I know living on this earth cost me exactly $20,132 in 2008. Not a hefty sum, but I’m also an unmarried student with no liabilities. It’s not as large as I’d eventually like, but it’s a good starting point that fills the basic requirements of covering expenses for a year.
10% Per Month, Every Month
To reach this goal, I’m putting 10% of my monthly income into a separate savings account each month. Ten percent isn’t a huge contribution, at this rate it will take 10+ years to reach one year’s worth of income. But as my income grows, I’ll make efforts to increase the percentage progressively, up to 30% or even higher.
Make sure you take any savings money off the top, instead of from the bottom. If you only save what you have left, often you won’t have very much left to put away. Automatically taking out the money forces you to adjust your spending habits.
I’ve always maintained savings, but I started contributing 10% a few months ago.
Don’t Touch the Money
For the emergency account to be effective, you can’t dive into it for reasons outside your purpose for having it. Saving for weddings, cars, houses or travel is great, but they are separate goals from financial freedom.
I’ll admit, this part of the advice will be difficult for me to follow. My income is still close to my expenses, as I haven’t grown this business to create a healthy gap between revenue and my lifestyle costs. Also, traveling on a foreign exchange will be costly.
Even if you can’t know with certainty that you will never have to dip into your emergency fund, there is still value in building the habits to start one. If you get used to allocating 10% of your income into a separate account, that habit will continue even when you’re earning a good income.
Creating the right habits is half the battle.
Freedom and Security
I think these current economic times have taught us there is no absolute security. Even with an emergency fund, you aren’t completely secure against misfortune. Freedom is a psychological goal. Having financial flexibility to switch businesses or careers without going into poverty helps, but it’s not complete.
Financial freedom means you accept the lack of complete security and prepare the best you can. But you don’t let money rule your life.