When you start organizing your finances, one of the most important recommendations you’ll hear about is the need to establish an emergency fund. Unfortunately, simply hearing “Stash away a solid emergency fund” isn’t always enough to get the point across. In this blog we explain what you need to know about emergency funds and why having one is so important.
What is an Emergency Fund?
In basic terms, an emergency fund is a specific source of money that is set aside to pay for unpredictable financial needs. It is not the same fund that is used to pay for vacations, new vehicles, or a down payment on a house; instead, it is a “rainy day fund” that is geared toward providing funds in the event of an emergency.
Many people fall into the trap of raiding their emergency funds for things that aren’t really true emergencies. An unexpected dinner out with friends, a forgotten birthday, or a sudden sale on an item that they’ve been waiting on for weeks isn’t an emergency. Some financial emergencies include:
- Necessary home repairs that might even impact your ability to live in the home. For example, storm damage, replacement appliances that you must have immediately like your stove or hot water heater, or other unexpected issues
- Unexpected car repairs
- Medical emergencies, especially those that must be paid for upfront
- Living expenses following a job loss or an unexpected period of time out of work
Ideally, an emergency fund should be readily accessible so that you can get to those funds quickly and easily in the event of an emergency. Your goal, with an emergency fund, is to avoid using credit cards or other high-interest loan options when a financial emergency presents itself – or, worse, to go without something essential because you can’t afford it.
How Much Is Enough?
Setting up an emergency fund sounds simple enough. You just need a little money set aside for the proverbial rainy day, right? Not quite! It’s also necessary to ensure that your emergency fund is sufficient to cover those emergencies–and that amount may vary based on your monthly expenses, income, your lifestyle, and your family size. When setting up your emergency fund, these guidelines can help:
- How long have you been saving? If your emergency fund is your first savings account, starting with $1000 is a great financial cushion that can help you get through some serious difficulties. Eventually, you’ll want to accumulate enough to cover several months of expenses.
- How much money would you need in order to make it through a month without income? What about two months? While the length of time necessary for you to find and start a new job varies, it’s important to make sure you have the funds on hand to carry you through most of that time. The more you have in an emergency savings account, the more time you have for your job search.
- Do you own a home? An expensive vehicle? Do you or any of your family members or pets have medical issues that are likely to cause an expensive potential emergency? Any of these things may require you to have a larger emergency fund on hand.
Ultimately, your goal with your emergency fund is to have the money on hand to cover an emergency from unexpected car repairs to a loss of income. When you’re on your own, you can get away with saving around three months of expenses. As your family size increases, especially if you have a single income, a larger cushion (six months or more) may be more appropriate.
How Do You Get Started?
Starting your emergency fund is simple: start saving! Set aside a portion of every paycheck to this specific savings account. It doesn’t, however, have to be a stressful process.
- Start small. If you’re starting off with a goal of being able to live for a year on your emergency fund, you may quickly become overwhelmed. Starting with a smaller goal makes it more manageable.
- Look for new ways to come up with savings. Many people feel as though their budget is already too tight to sneak out savings every week. Finding creative ways to save, however, can help! Cook more often at home, shop sales, or look for a better deal on your cell phone or cable. Commit to staying out of your emergency fund for other expenses. If it’s not an emergency, that’s not what your emergency fund is for!
- Keep saving. Those little bits of savings can quickly add up to make a big difference, especially if you’re committed to building your emergency fund over a period of years.
We believe that your emergency savings account is one of the important steps to financial freedom. With a solid emergency fund, you can weather what might otherwise be a financial disaster. Don’t put it off for tomorrow and assume that disaster won’t strike. Inevitably, financial disaster arrives when you least expect it and unfortunately your life is no exception to the rule. Instead, get started with your emergency fund on your next paycheck. When your next emergency arrives, you’ll appreciate the forethought.