Before you start investing or making major purchases, your first priority should be to have an emergency fund. An emergency fund means you have the amount of money you would need to live off of for 3-6 months in a savings account.
How To Calculate The Emergency Fund: Thus, take the amount of money you spend on food every month, along with essential transportation costs, housing costs, and your average monthly expenditures on one-time purchases. Take whatever that figure is, let’s say $1200 and multiply it by three. Thus, You should have $3,600 in a savings account before you start investing a single cent. If you are older and have graduated from college, you probably want that amount to be higher with 4-6 months of savings being more appropriate. However, this is not just for young people. Everyone for all ages should have this emergency fund and the amount of money you need to have in this fund will likely increase as you get older.
Why You Need The Emergency Fund: Something unexpected that effects your income can occur at any time. You could lose your job, you could get injured, etc… The emergency fund is the best way to ensure that you never end up in serious debt. You never want to be in the position where your credit card debt rolls over from month to month, but if you don’t have this emergency fund then that’s exactly what will happen…and that debt is the worst possible kind of debt.
Why You’re Lucky: If you’re still young and in college, odds are your parents would be able to help you out if any of these unexpected things occurred. Thus, you may only decide that you want 1-2 months in your emergency fund. While most professionals would not recommend a fund this low, if you feel confident in your parents’ ability to support you then I think that’s fine. It gives you a great opportunity to take the extra money and experiment with it. College is the perfect time to start investing in stocks because if something goes wrong you can afford the loss. In fact, the best way to learn will be from the mistake or two you make, and it’s better to make those mistakes now than in a decade.
Remember, money that you have invested in stocks do not count towards your emergency fund. You do not want to be in a position to pull that money out of stocks in order to avoid debt as you should be investing for the long-term.
Regardless of your current financial situation and how long of an emergency fund (1-6 months) you need, it’s good to know the amount of money you need every month, and as you become more independent make sure you give yourself that emergency fund, stored in a savings account, as it is one of the most important steps to avoiding debt and staying financially secure.
Finally, one last word of caution. While the emergency fund is important, don’t go overboard in the other direction. If you have more than 5-6 months worth of expenses saved up, then you should do something with your extra savings. If you’re saving towards a big purchase such as a car or house, you can put that money into a CD (which gives you a fixed income such as 4% for the length of the CD). Otherwise, you should take that surplus savings and invest it in some kind of index fund.
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