Becoming a black belt and having a “mind like water” in your personal finances is very similar. It means you can take whatever is thrown at you without knocking your finances out of control. You can respond to any situation with perfect balance. Unexpected events or changes in your finances, good or bad, can be handled with optimum efficiency, and little or no stress. It means you can direct the flow of money where you need it almost effortlessly.

In an effort to help people gauge where they are in their personal finance development, I’ve defined what people at the various “belts” might look like. Where are you?

White Belt

You’ve recognized there is a problem with your finances and have committed to taking control. Recognition that there’s problem may come as a nagging doubt that you’re not meeting all your financial goals or a harsh reality check as you face mounting debt. You have a lot of stress concerning finances (even if you’re living within your means). You tend to fight with your spouse every time you discuss financial matters. You recognize your spending isn’t in line with your true values. You have no idea where all the money goes from month to month. You may be living paycheck to paycheck. If you saved $5 on your phone bill, it would just disappear somewhere but you don’t know where. Your idea of an emergency fund is a credit card or Home Equity Line of Credit. You frequently pay late fees on your bills and unnecessary bank fees. Net worth? What’s that?

Despite your lack of financial control, you have a strong resolve to take action even though the thought of facing the “deep mess” of your finances seems overwhelming. You and your spouse have agreed to work together. In an effort to get your spending under control, you’ve started using cash for your “out-of-control” budget categories. You’ve stopped using credit cards somewhat reluctantly and possibly out of the sheer pain of your dire financial straights. Despite some complaining, your family has agreed to use cash as well. You’ve taken initial steps to figure out what your basic monthly income and expenses are and have tried budgeting for at least one month even though it doesn’t match reality yet.

Most importantly, you’re no longer willing to BE IN DEBT!

You’re no longer willing to constantly WORRY ABOUT MONEY!

You’re no longer willing to FIGHT ABOUT MONEY!

You’re no longer willing to PAY LATE FEES!

You’re committed to TAKING RESPONSIBILITY FOR YOUR FINANCES!

You’re committed to WORKING THROUGH FINANCIAL ISSUES TOGETHER WITH YOUR SPOUSE!

White belts come in many shapes and sizes. Of course, those steeped in debt and on the verge of bankruptcy can be white belts, but so can those who are living within their means (see below). Being a white belt means you don’t have total control over where your money goes. Your spending doesn’t reflect your true values and is not conscious. The white belt is about recognition and commitment. You’ve recognized a need to change and are committed to doing what it takes to change.

Green Belt

You’re well under way implementing your financial-management plan. You’ve budgeted for at least 3 months in a row and have worked many of the kinks out. Your budget actually reflects reality.

You meet with your spouse about every two weeks to keep things on track. You often have to implement the 30-minute rule and meet several days in a row to prevent total melt-downs.

You’ve taken all credit cards out of your wallet and are using cash for all of your “in-person” spending. As a result, for the first time you feel like you have control over your spending. You’ve even started developing your own unique ways of managing your cash and have a tendency to give spontaneous testimonials about the virtues of cash whenever someone acknowledges your use of a cash envelope.

You’re well under way saving for a short-term emergency fund. You may not have it fully funded yet but you already notice feeling much less stressed having at least something in place. For the first time in your life, you may have even experienced an emergency and had the money to pay for it. You have created an initial net worth statement and have a general idea about your overall financial status.

If you saved $5 on your phone bill, you could probably redirect it rather than letting it disappear. You no longer pay late fees or bank fees. If necessary, you’ve made major changes in your lifestyle to ensure you can live well within your means.

Brown Belt

You’ve been on a zero-based budget for over 6 months and things are really humming. You may have occasional refinements, but things are mostly on cruise control. You’re able to manage your finances on one meeting a month and are able to get through most meetings without any arguments.

You’ve gone through at least one set of envelopes. You find that you’re keeping the cash envelopes the bank gives you when you cash a check or make a withdrawal because they are a better size than regular envelopes.

You’re friends have started noticing that you pay cash all the time and have asked you about it. You find yourself preaching the cash gospel and sharing your success whenever you can.

You have a fully-funded short-term emergency fund and have started reducing consumer debt or increasing retirement savings. You have a strong sense of control over your finances and can see significant improvement every time you refresh your net worth report (which you do at least once a quarter). You and your spouse have reconciled your financial differences and have a new-found sense of unity when it comes to finances. You’ve created a list of rules concerning what you both consider to be an emergency as well as what you want to do with any unexpected windfall money. By making these decisions ahead of time while you’re calm, you avoid big arguments when these events occur.

Black Belt

You laugh in the face of emergencies (mua-ha-ha) and can easily and confidently deal with anything thrown at you. Seriously, for all practical purposes financial emergencies don’t really exist for you any more. If you save $5 on a phone bill, you’re financial system allows you to know about it and easily redirect it exactly where you want. You have complete financial control over every dollar.

You no longer worry about finances. Instead of worrying about how to pay the bills on time, you think about what investments to make or which debt to pay off next. You’re amazed and shocked that people even pay late fees (you obviously are having a bout of selective amnesia). You are aggressively on track to pay off all consumer debt and/or save for retirement. In fact, sometimes you find it hard to spend extra funds because you’re so excited to become debt-free that you want to reduce your debt instead.

You finally feel like where you spend your money is a reflection of your true values. You and your spouse see eye-to-eye concerning finances. You only have major financial discussions when your financial situation changes dramatically.

You not only calculate your net worth quarterly, but also have calculated when you’ll become financially independent.

You kind of wish you’d get fired so you could find a job you really like (you have a full emergency fund and could get by for 3 to 6 months without any income). You only have to spend about 30 minutes a month on average managing your finances. You’ve cut up all your credit cards because you just don’t need or want them anymore.

Your belt level isn’t about debt, savings, or your net worth.

Some of you may have noticed that my description of the belts didn’t include savings percentages or require you to be debt-free. Your belt level isn’t about debt, savings, or your net worth. It’s about your ability to control your money, ensuring that each dollar is directed where you want. I’m sure I’ll get a lot of flack for saying this. Of course, savings and debt elimination are cornerstones of a solid financial foundation. But to enable you to save and pay off debt, you first have to get a handle on your inflows and outflows. As you gain greater levels of financial control, you can easily reach your savings and debt-reduction goals at an ever-accelerated rate.

The good news is, you can become a financial black belt even if you still have debt or haven’t reached your long-term goals. Of course, if you are a black belt, it won’t be for long before you do. As you progress in your career and get raises, or as you receive windfalls, you will be able to direct those extra funds with great focus and power to eliminate debt and reach your long-term goals. That’s the power of a black belt.

Take your finances to an “11″

I can’t avoid referencing this segment from This Is Spinal Tap. If you haven’t seen it, you should take a look.

I know many people who live within their means, pay off their credit card bill every month, and think they have arrived in terms of financial management. But the fact is, you can do these things and still be a financial white belt. I know this for a fact because I’ve been there.

There was a time when our income greatly exceeded our expenses. We saved ten percent and gave to our church. We also lived large and bought just about anything we wanted and were still living within our means. For the most part, we just accumulated a bunch of “stuff” and made a lot of emotional, at-the-register purchases. As we look back we kick ourselves for not using that money in a more conscious way. Had we been financial black belts, we could have greatly accelerated our journey to financial independence. Today, even though we have downgraded to a single income and increased our expenses (mortgage, child), we are doing more with what we have now than we did with two incomes, no children, and low living expenses. As a result we have been able to reach financial goals with tremendous speed and ease.

I’m not saying you have to choose between having fun with your money and saving it for later. As a black belt, you can set aside funds for frivolous spending and still aggressively meet your financial goals. The key is to spend consciously, making decisions as they relate to your values and your finances as a whole. If you plan wisely, you can have the best of both worlds.

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I was wondering if you could mention some practical ways of building a STEF; any advice would help, especially for those on irregular incomes.

There’s really no trick to building an STEF. It’s mostly a matter of focus and making it a priority. That being said, here are some ideas to help get you started.

1. Make it a priority – Once your fixed bills and necessities are funded in your budget, your next highest priority should be building your STEF. You’ll hear many financial advisors talk about paying yourself first. While they typically are referring to saving for retirement, saving for a STEF would also apply.

2. Use easily-divertible savings or debt reduction – One of the quickest ways to build your STEF is to temporarily divert money that you’re currently using for savings (retirement or college) and debt reduction. Often these amounts are relatively large and can accumulate quickly.

I DO NOT recommend diverting funds going into a 401K or that are hard to divert. At my work it would take paperwork to divert my 401K and then I would have to wait until the open enrollment period to start contributing again. In such cases, it’s better to leave it alone.

3. Sell “stuff” – Most people have hundreds, if not thousands of dollars of “stuff” laying around; Electronic gadgets that are no longer used, old mp3 players, sporting equipment, TVs, furniture, clothing, toys, computer games. Have a huge garage sale!!! Not only will this give you a nice jump start on your STEF, it will also lighten your load physically and even emotionally. This method can be so effective, some people can even save their whole STEF by selling stuff.

An alternative to a garage sale is selling things on ebay.com, half.com or craigslist.com. There are many great auction and second-hand sites that allow you to sell your stuff (if you know of a good one, leave a comment). My wife commonly buys clothes on ebay for our son in bundles. She just bought a bundle that cost about $1 an item and it came with about 20 items. Suddenly older clothes that seemed worthless can now make you a tidy sum.

4. Buy large-ticket items at a discount – I have a friend that almost always checks ebay first when he wants to buy something over $100. I wouldn’t necessarily recommend buying everything used. If you’re buying less-expensive items and only saving a dollar or two, it’s probably not worth the effort, at least for me personally. If you have the time and inclination, go for it. On items over $100, however, your savings can be significant. Buying used items on an auction or second-hand website, going to garage sales, or shopping at second-hand stores can yield tremendous savings on big-ticket items.

If you have kids, you can really take advantage of second-hand items. By visiting a quick round of garage sales on a weekend, you can find a ton of used toys, clothes, and kid furniture at a small fraction of the “new” price.

5. Go on a spending fast – I wouldn’t recommend doing this for the long term, but for a month or two you could consider a spending fast. Find all the variable expenses that you could significantly lower or eliminate for a short term. Take your lunch to work for a month, put your newspaper subscription on hold for a month, clip coupons, go to the library instead of the movies. Making small adjustments can add up with enough focus. A word of caution though; this suggestion alone won’t get you enough for a full STEF very quickly. You will also need to use one of the other methods. If anything, this suggestion puts you in the right frame of mind and helps your focus.

6. Cancel unnecessary billed “stuff” – Many people pay well over $100 a month on various subscriptions such as cable, internet, cell phones, publications, movie-rentals (netflix), etc. While you want to be careful about incurring large cancellation fees, see if you can cancel or eliminate those you don’t need or use. Or try to live without them for a month or two. I’ve never tried it, but I bet you could put your satellite or cable service on hold for a month or two. You might even get out and do something active (gasp)!

7. Get temporary employment – Get a newspaper or pizza delivery job for a month. Or better yet, find some freelance work involving something you enjoy. Doing so may even lead you down the path of becoming self-employed. If you work as a web developer, call some local small businesses and see if you can do website work for them. You’d be surprised at how open many businesses are open to hiring temporary contract work to solve small annoyances.

A good place to start is a friend or family member’s place of employment. You could simply have them ask a manager or executive if there are any small, annoying projects they would like to get done and out of the way. I can almost guarantee they will think of something if they think long enough. One of my co-workers has his wife do mailings for our company that go out periodically and she makes a nice side-profit.

One last suggestion on this topic. Find some skill or job you would like to have and see if you can get a job learning it. Have you always wanted to learn to do construction? Ask around and see if there’s a builder that will let you work with him on weekends. Most people don’t take time to be creative when it comes to making money. A little creativity can go a long way and make you stand out, while simultaneously helping you achieve your financial goals.

8. Reallocate funds – Look in all your accounts and allocate the current balances. Once you know how you’re going to use every dollar (make sure you allocate enough for paying bills) see if you can reallocate any of those funds as a STEF. Most people have an amorphous blob of money sitting in their accounts and don’t know exactly what it’s for. They just hope there’s enough to pay all the bills for the rest of the month. By allocating your balances, you may find there’s some money left to start your STEF. Some will find large sums of money they can use. In fact for those who live within their means but just don’t have a very good budgeting system, you might find you already have your full STEF just sitting around (wouldn’t that be nice?).

Make it your #1 personal finance goal – Accumulating a STEF should be your number one personal finance goal. Make a goal to accumulate a STEF within a specific time period and think about new and creative ways to meet that goal. There seems to be a law of the universe that once you totally dedicate yourself to achieving a goal, things often fall into place that you could never have anticipated. In addition to specifically taking action, many find that just by focusing on accumulating a STEF, they have unexpected windfalls that help them achieve their goal; a bonus at work, an unexpected tax refund, a generous gift.

How are you going to save your STEF? Leave a comment and let us know!

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• 6 ways a short-term emergency fund can help save your budget

Overview

• Use cash for out-of-control categories – Since you may not know when your next paycheck will be, it’s more important than ever to keep a tight grip on variable expenses that tend to get out-of-control.
• Build up a short-term emergency fund (STEF) equivilant to four weeks of expenses – A STEF will help smooth out the bumps inherent in an irregular income
• Determine the timing and priority of expenses ahead of time – Planning the order in which expenses must be paid and allocated will relieve a ton of stress. You’ll know exactly where your income needs to go before you even get it.
• Create a sample budget as a reality check and baseline – A sample budget helps to ensure you are not only living within your means but also achieving your high-level, long-term financial goals.
• Chunk your income and allocate it once or twice a month – By using your STEF as a shock-absorber for fluctuations in income frequency, you can almost budget like a good-old corporate employee. While you may not envy the corporate lifestyle, a steady paycheck sure makes budgeting easier. By allocating your income in chunks you can budget like a corporate employee while keeping a self-employed lifestyle.
• Create a “just-in-time” budget, allocating only what you need until the next paycheck – By allocating only what you need until your next paycheck, you’ll be able to squeeze every penny out of each inflow. Don’t allocate your full grocery budget for the month if you only need half of it until your next paycheck.

1. Use cash for out-of-control categories

My first recommendation is to use cash for variable expenses that tend to get out of control. This is crucial for living within your means. You’ll be amazed at how much you can reduce and control your spending just by following this principle. Using cash will give you complete control over the total amount you spend in a given category. When the cash is gone, it’s gone. This is especially important when you need to make the most of each monetary inflow because you may not know when your next inflow will be.

2. Build up a short-term emergency fund (STEF) equivilant to four weeks of expenses

The second step is to build up a short-term emergency fund equivilant to 4 weeks of expenses. This step alone could save you hundreds of dollars in late fees and will give your life a little more peace. It will also keep you from going into debt when an emergency hits. Most importantly for those with an irregular income, a STEF will allow you more flexibility in budgeting and will help compensate for lost income during periods of unemployment or under-employment. For detailed instructions on how to create and manage a STEF, see my previous post.

What if your income varys drastically?

If your income varys drastically, you may want to increase your STEF to 2 or even 3 months of expenses. The more drastic the fluctuations the more of an emergency fund you’ll need. The goal with the emergency cushion is to store up funds in times of plenty to compensate for the times of scarcity. Start with a STEF of 4 weeks and adjust up as needed. However, don’t adjust down. A STEF should be a minimum of 4 weeks of expenses.

3. Create a “Timing of Expenses” list

A “timing of expenses” list simply shows all your bills and when you have to pay them. This will help in our next step to prioritize the order in which expenses should be paid. It will also act as a reference to help ensure you pay your bills on time. To avoid late fees, make sure all your bills are on auto-pay. If auto-pay is not available, highlight the bill so you’ll always remember to pay it on time. As you write your bills down, note on each item if the payment day changes from month to month. There are three main scenarios:

• Paid on the same day each month (e.g. on the 15th of every month)
• Paid every x number of weeks (e.g. paid every other Tuesday)
• Paid every x number of days (e.g. paid every 30 days).

Once you create this list, updating it every month should only take a minute. After a few months you should be able to predict within a day or two when each expense will occur.

4. Create a “Priority of Expenses” list

Note: The “priority of expenses” list and the “timing of expenses” list can be combined depending on personal preference.

When living on an irregular income, it’s important to have clarity ahead of time about exactly where your income will go when you’re paid. Having a pre-determined plan combined with a STEF will help you sleep well at night and decrease the feelings of impending doom and uncertainty that you won’t be able to pay the bills. The “priority of expenses” list is the main tool in helping you decide ahead of time where your income will go. It is essentially a budget arranged chronologically and by importance, rather than by grouping similar categories. You will refer to this list every time you are paid in order to determine where the money goes.

First, list out all your bills in chronological order

List all your bills in chronological order. This will show you the hard landscape that your other categories have to fit around.

Next, list out the rest of your remaining budget categories in order of importance

For most, this list will probably start with necessities like grocery and clothing, followed by high-priority items like savings (STEF, retirement, long-term savings) and debt reduction. Of course, housing would also be considered a necessity but is probably listed under “bills”.

As an example, my list might be ordered like this:

• Bills (in order of date due)
• Mortgage – 12th
• Utilities – Every third wednesday
• Car payment – 23rd
• Allocations (in order of importance)
• Grocery
• Gas
• Cushion
• STEF (if needed)
• Retirement savings
• Medical
• Car maintenance
• Haircut

This is an extremely abreviated list but you get the picture. After the bills, the most important categories are first and the least important, last. In other words, I first need to make sure I eat and can pay for necessary travel. Then I want to make sure I pay myself (retirement savings) and replenish any STEF if needed. Expenses like medical and car maintenance may not be used every month but will accumulate over time. Therefore it usually won’t matter when in the month I assign those allocations. If I happen to be sick early in the month, I could either use medical funds already allocated in previous months or move that expense up on the list for just that month. Finally, I figure I can allocate my haircut last. If I have a bad month, I could go without one entirely.

Your “priority of expenses” list shouldn’t vary much, if at all, from month to month. Include all your budget categories, even if they don’t apply every month. If you have categories that don’t apply in a certain month (like birthdays), just skip it and move to the next category when allocating funds.

5. Create a sample budget as a reality check and baseline

Having an unpredictable income makes it hard to ensure you’re meeting all your financial obligations, not to mention your financial goals. Therefore, it’s important to create a sample budget based on averages to see if you can meet your obligations AND achieve your goals, despite fluctuating income. The sample budget will give you a baseline from which you will vary from month to month based on your actual income. You should update your sample budget whenever you have a significant change in overall income or expenses to ensure you’re still on track with your long-term financial goals.

First, calculate your average income over 6-12 months. Then calculate your typical monthly expenses including contributions to savings and other financial goals (e.g. debt reduction). Enter in budget amounts for a sample month including these income and expense figures.

If you can’t meet all your obligations AND financial goals on your current average income, you’re due for a change. Otherwise you will never get ahead and always be flirting with increased debt. You need to eliminate unecessary expenses or find additional income streams until you can meet all your obligations, necessities, AND savings goals on your average income. In some cases, a dramatic change in lifestyle may be in order.

6. Creating your actual budget – tips and tricks

Now it’s time to create your actual budget. All the steps until now have helped you create a solid set of reference materials to help you make budget decisions. In fact, you’ve basically made all the decisions about your budget already. Now you simply need to adjust the timing of payments and allocations based on when your income is available and how much there is.

Dealing with income

There are two ways to deal with income depending on how frequently you’re paid. If inflows are infrequent – roughly once or twice a month – treat each check individually and allocate it only for the time period until your next check. If inflows are frequent – roughly more than four times a month – group the inflows and allocate them once or twice a month.

Allocate infrequent inflows check by check

If you’re paid once or twice a month, it’s most efficient to allocate each check individually for the time period until your next check. Let’s look at an example. Let’s assume you are paid $2,000 on the first of the month and you anticipate you’ll be paid again in ten days. Refer to your “priority of expenses” list, determine which bills are due in the next ten days, and allocate the $2,000 accordingly. If the $2,000 doesn’t cover all your bills, or it doesn’t cover the bills and your necessities (e.g. food) for the next 10 days, use funds from your STEF and allocate it as needed. In this case you would designate the STEF amount used as “income” on your budget.

If the $2,000 covers all your bills and necessities for 10 days, continue on down your “priority of expenses” list allocating until the $2,000 runs out. Remember, after your necessities are allocated, replenishing your STEF should take top priority.

Allocate frequent inflows in chunks

If you recieve inflows more than four times a month, it’s easiest to allocate your income in chunks rather than each inflow individually. If you recieve your income in the form of checks, save them up and deposit them twice a month. If your income is automatically deposited into a bank account, just wait and allocate it all every two weeks. It’s easier to allocate a larger chunk of income twice a month than to constantly be allocating fragmented deposits. With your full STEF in place, you’ll be able to safely deal with income twice a month without worrying about negative bank account balances. The STEF acts as a shock absorber, allowing you to budget almost as though you had a regular income.

Split up single budget categories and allocate them in smaller pieces to create a “just-in-time” budget

Occaisionally you may want to split up a single category, allocating part of it with the current inflow and part with a later inflow. If income is tight, this type of optimization will help you squeeze every penny out of a paycheck. By doing so, you create a “just-in-time” budgeting system, allocating only what you need, when you need it.

For example, Let’s say you have an inflow of $2,000 at the beginning of the month. $1,000 may go to a housing payment, $200 to utilities, and $300 for a car payment leaving you with $500 to allocate. Even though you could fully fund a $300 grocery budget category with the remainder, doing so wouldn’t leave enough for other categories like gas, personal, and cushion. Instead, if you think your next inflow will be in two weeks, just allocate what you think you’ll spend in the next two weeks on each budget category. Instead of allocating the full $300 for grocery, you might be able to get by on $150, leaving you more money to allocate to your other important categories and making it less likely you’ll need to dip into your STEF.

Allocate bills/obligations first, then everything else

Every time you allocate money for a period, follow the “priority of expenses” list, first allocating your bills and obligations and then allocating the rest to your other expense categories according to priority. Your allocations may vary from month to month but having the “priority of expenses” list should make the process much easier.

What if I make more than average in a month?

If you make more than average in a month you should have already referred to your “priority of expenses” list and funded all your budget categories. With the remaining income you should fully replenish your STEF to prepare for future months when you recieve less than average income. Allocate the rest however you want.

What if I make less than average in a month?

First cover all the expenses you can from your allocated categories. Hopefully you will already have most of your expenses allocated already. If you run out of income to allocate, you can either take money from your STEF or skip the remaining categories if they are optional (like “haricut”). Fortunately, by the time you run out of income to allocate you should be near the end of your list where the categories are less important. Depending on how much your income varies, you may need to dip into the STEF quite a bit. It’s ok, that’s what the STEF is for. In the worst-case scenario, you should be able to cover a whole month of expenses on NO INCOME.

Conclusion

With a little planning and a methodical approach, budgeting on a self-employed or irregular income can be just as easy as budgeting on a regular income. By using the techniques above, you can take much of the variability out of your planning and know ahead of time exactly where your money should go.

Please let me know your comments and questions. Also let me know if there are points that need additional explanation or clarification. Do you have any additional tricks you’ve learned? Please leave a comment and let me know!

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A short-term emergency fund can:

1. Prevent major budget disasters
2. Help you prevent fees from late bill payments, overdrawn accounts, and insufficient funds.
3. Keep you out of debt when emergencies occur (or from going into more debt).
4. Smooth out errors in electronic-funds processing.
5. Help smooth out large fluctuations in income for those with self-employed or irregular incomes.
6. Help you get a month ahead instead of always playing catch up

This post will address the benefits of a short-term emergency fund as well as how to create and manage one.

Benefits of a short-term emergency fund

1. Prevent major budget disasters

Emergencies large and small are a huge obstacle to consistent budgeting. Many go through all the effort and pains of creating a budget only to have it completely thrown off course at the first emergency. They figure that budgeting just doesn’t work and give up. A short-term emergency fund (I’ll use STEF for the rest of the post) will allow you to absorb emergencies and stay on track. In all but the most extreme situations, your budget will stay in tact and may not even change at all.

2. Prevent fees from late bill payments, overdrawn accounts, and insufficient funds.

Even with a budget in place, you still may run the risk of having more bills come due between paychecks than you have funds in your checking account to pay. One overdrawn account can trigger not only its own fee, but can cascade down the line causing late bill payment and insufficient funds fees. One occurrence can easily add up to over $100 dollars. Your STEF will make these fees a thing of the past. You will never have to worry about having enough funds at the right time. Even better, you will never pay these outrageous fees again.

3. Stay out of debt when emergencies occur (or from going into more debt).

What do you do when there’s an emergency? Most people pull out the credit card. Medical providers are also great at setting up payment plans to help you go into debt. The emotional effect of such emergencies makes you feel like there’s no use trying to get out of debt. Imagine if you were able to pay that $1,000 medical bill in cash! With a STEF in place, you can.

4. Smooth out errors in electronic-funds processing.

I’m a huge proponent of automatic and electronic payments. However, with the blessings of technology come some occasional curses. Errors in payment processing due occur and are not all that uncommon. They are usually fixed quickly. But if your direct deposit was a few days late and your mortgage payment occurred the next day, you could be in trouble. With an STEF in place, you won’t even notice these glitches.

5. Smooth out large fluctuations in income for those with self-employed or irregular incomes.

I’ve had many comments asking how to budget on a self-employed or irregular income. While I plan on addressing this issue more closely very soon, creating an STEF should be your first step. The more your income fluctuates, the more important an STEF becomes. Your STEF will absorb those months when income is lower than usual and can be replenished when your income is higher than usual. Budgeting will be easier to manage and much less volitile.

6. Get a month ahead instead of always playing catch up

Essentially, an STEF helps you get a month ahead of your expenses. Instead of ending the month with close to a $0 balance in your checking account, you will always have a buffer of hundreds or thousands of dollars. The STEF will help eliminate anxiety about whether there’s enough money to pay the bills or if you’re going to bounce a check. Without the STEF in place, you will have these worries even if you’re budgeting correctly.

A short-term emergency fund should be the first priority in your financial strategy

A short-term emergency fund is so important, it should be your first financial priority, even before savings, retirement, and debt reduction. I’m NOT necessarily saying you should stop your 401K to build an emergency fund. I AM saying you should divert as many liquid funds to your STEF as you can.

What is a short-term emergency fund?

A short-term emergency fund should consist of 4 weeks of expenses not including savings, debt-reduction, or other expenses that could be put-off or skipped in case of an emergency. With an initial budget in place, you should have a pretty good idea of how much this is. Imagine you had an emergency and you lost your income for a month. How would your spending change? Which spending categories would you eliminate? Your STEF should only cover those expenses that you would still have in an emergency situation. My wife and I have debated if you should include only necessary expenses or all expenses. I truthfully don’t think it really matters that much. JUST START! Calculate only the necessities and save that amount first. Once you reach it, you can decide if you want to save enough to cover all expenses. Even a small or under-funded STEF can provide the benefits outlined above, so it’s most important just to start as soon as you can!

Ideally you should also have a long-term emergency fund but it will take a lower priority. Other things, like paying off debt and saving a consistent amount for retirement, should take precedence over a long-term emergency fund. I will address the long-term emergency fund in a later post.

How to use a short-term emergency fund

Your STEF should reside in the main checking account you use to pay your bills and expenses. If you have multiple accounts from which you pay bills, split up the short-term emergency fund and put just the amount you need in each account to pay one month of expenses from that account. For example, we pay our mortgage from a separate checking account because we got a better rate on our mortgage. We ONLY pay the mortgage from this account so we placed an amount equal to the mortgage payment as a short-term emergency fund in that account. I hate that we were forced to use a separate account because it’s a hassle to manage and keep track of, but if you have a similar situation at least you’ll know how to deal with it. Ideally you should pay all your bills from one account for the sake of simplicity.

Rules for managing your short-term emergency fund

There are a few rules you should follow in building up and managing your STEF.

1. Get a STEF in place as quickly as humanly possible.
2. The STEF is not a “blow” fund. ONLY spend it on emergencies!
3. When used, the STEF should be re-funded as quickly as possible.

Let’s cover each rule in more detail

1. Get a cushion in place as quickly as humanly possible

Do your best to save your STEF AS FAST AS YOU CAN. Using cash for your out-of-control categories will hopefully result in some extra savings which you can divert to the STEF. I would even temporarily divert other long-term savings, assuming they are easy to re-direct and wouldn’t require extensive paperwork. With enough focus, many people can save a full four weeks of expenses within 2-3 months.

2. The STEF is not a “blow” fund. ONLY spend it on emergencies!

The STEF is NOT a blow fund or a cushion used for month-to-month budget errors and oversights. The STEF should be used ONLY for emergencies. If you’re self-employed the STEF may also be used to cover your expenses if you have an unexpected low-income month.

Emergencies might include:

• Not receiving expected income on time
• An unexpected period of unemployment or under-employment
• A Car breaking down
• Unexpected illnesses or injuries
• Travel expenses due to a funeral
• Unexpected household expenses (the fridge or air-conditioner break)
• Traffic tickets (ok, my wife might disagree with this one)
• An unexpected tax burden (this should ideally be avoided with good planning but…things happen)

Emergencies DO NOT include:

• Planned car maintenance
• Expected or small medical expenses
• Vacations
• Birthdays
• Christmas
• Clothing
• School supplies
• Unexpected expenses under $100 that should be covered by your monthly “cushion” budget category

Is it an emergency?

Some scenarios may walk the line between an emergency and a planned expense. For example, you know your car will probably break down at some point but it’s very difficult to predict WHEN and HOW MUCH it will cost. How you deal with this is up to you. You may want to start a “car replacement” or “car repair” budget category. Or you may decide to rely on the STEF when your car breaks down. I like having a “car repair” budget category that can be used to purchase a new car if I don’t have any major repair costs.

Create an “Emergency Rules” list

Creating an “Emergency Rules” list will help you decide ahead of time what you consider to be an emergency. Think about some of the “gray area” expenses and decide how you will react. You can use the lists above as a starting point. An “emergency rules” list helps you prevent deciding in the moment and calling something an emergency expense that shouldn’t be. If you are married, the list will be an argument-prevention device. You can negotiate while you’re calm and collected instead of waiting until an emergency occurs and you’re both stressed out. My wife and I have used our list many times and continue to revise and refine it every few months.

3. When used, the STEF should be re-funded as quickly as possible.

The last rule for your STEF is that, when used, it must be re-funded as quickly as possible. One danger is that you’ll use the STEF as an excuse to spend irresponsibly or unco\nsciously. If you spend more than you planned in a month it’s easy to say, “it’s ok, we have enough money in our account.” Before your know it, the STEF is depleted and you’re back at square one. To prevent this you must religiously account for your STEF every month. If you use it, replenish it as soon as possible. Because emergencies are typically large expenses, it may take a few months to fully replenish the emergency fund. But at least it will have prevented you from going into debt.

Start Today!

As I mentioned, even a small, under-funded short-term emergency fund can provide you significant benefits. The sooner your start building your STEF, the sooner you can lower your stress and smooth out your financial journey. Please leave a comment with your thoughts. If you have a short-term emergency fund already, share your experiences.

Be sure to TELL A FRIEND about GFD! I want to help as many as I can to obtain stress-free financial control and meet their financial goals.

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