What Exactly is an Emergency Fund?
An emergency fund is exactly what it sounds like. It is an amount of money put aside to deal with unexpected emergencies that happen in life. This money is used like insurance against the inevitable financial pressures that we all will face when we incur major expenses or we lose a job. Home roof repairs, major plumbing repairs and vehicle repairs are just a few examples of the types of major expenses covered by an emergency fund. Emergency funds should also be able to cover your monthly household expenses in the event that you lose a job.
Why Have an Emergency Fund?
Quite simply put, an emergency fund provides you peace of mind. The stress associated with some of these emergencies can be devastating. Why add financial stress to the list if you don’t have to? Committing to a small amount of planning and saving on your part now can save you both fiscally and mentally in the future.
How Much Money Should I Stash Away?
It really matters who you are. If you are part of a single earner household I would recommend saving 6 months worth of expenses. While if you are part of a two member earning household you would be better off saving 3 months worth of expenses. The two member earners can save less because they always have the other partner to rely on if they are ever faced with unemployment. The single earner on the other hand only has savings to fall back on if they lose a job.
Where Should I Put My Emergency Fund?
Due to the unforeseen nature of an emergency, liquidity is key to deciding where to put your emergency fund. What good is saving money away for an emergency if when the emergency happens you can’t access the money?
Many believe that a checking account is the best place to keep an emergency fund. I prefer the high yield savings account though. Why not earn interest on money that is sitting there waiting to be needed? As long as it is easily accessible, this in my opinion is a better option.
This money should never be in the same account used for daily expenses nor should it be tied up in long term investments. Remember liquidity is key.
How to Build an Emergency Fund?
- Calculate your Monthly Expenses
Sit down and go through all your monthly bills. Determine from those exactly how much money it takes you to cover all your monthly expenses.
- Set Goals
Now that you have a feel for exactly how much your bills add up to every month, it is time to start setting savings goals. Whether it is three months of expenses, six or something entirely different it is good to set goals that guide your choices.
- Create a Budget
Once you have calculated your monthly expenses creating a budget will be much easier. Figure out exactly how much you would like to spend, but more importantly save from every paycheck.
- Adjust Savings
After implementing your new budget for a while, go back through it and see where you can save more. The faster you complete your emergency fund, the better off you will be.
When Should I Use My Emergency Fund?
As the title implies, emergency funds should only be used in the case of an emergency. With that being said, what exactly is an emergency? For some people it may be a trip to Starbucks. I can assure you, that is not an emergency.
Here are a few parameters I use to determine whether the thing I want to take money out for is an actual emergency or not.
- Is it urgent?
- Is it an unforeseen?
- Is it critical?
A great deal on shoes may be urgent and unforeseen, but it is by no means critical so unfortunately it does not qualify as an emergency. An emergency medical expense on the other hand meets all three criteria.
When Should I Start Building My Emergency Fund?
No one ever knows when an emergency is coming. It may be tomorrow or it may be 5 years from now but it is coming. Due to the fact that we don’t know when it will arrive you should start building your emergency fund today. Savings of any kind takes time to build. The earlier you begin, the better you will be when emergencies happen.