Do you feel anxiety about getting sick, losing your job, or your car breaking down? An emergency fund will lift that anxiety off your shoulders and let you confidently conquer the day.
Remember that jar of change your grandma used to keep on top of her fridge? The one behind the oldest Raisin Bran in the world? She might’ve called it her rainy day fund. “Only for emergencies,” she’d say; especially on the occasional afternoon when you were in a funk and unconsolable. That’s when she’d snag a few dollars from the jar and take you out for a scoop or two.
Well, maybe grandma was a little too liberal with her fund. Or maybe those scoops were fair use. Either way, she was onto something.
Now you’re an adult, and most of your problems can’t be solved with ice cream anymore. Grandma might still be around, but you’re wheeling her to Baskin-Robbins these days. So hopefully you appreciated all those times she treated you to Rocky Road with her fixed income. You’re grandma now, and you’re going to need a bigger jar.
What is an Emergency Fund?
An emergency fund is three to six months of income kept in a savings account reserved exclusively for emergency expenses. What you consider an emergency expense can differ, but at a minimum they include: medical bills, auto repair, and unemployment. It’s simple: save some money, make a specific list of emergency expenses, and don’t touch the money unless it’s an emergency.
Why You Need an Emergency Fund?
Why do you need an emergency fund? Because it turns most accidents into no-big-deal. If you’re paying attention to your money, you’ve probably imagined what it would be like if your financial fears came true. You probably have anxiety about financial emergencies. You need an emergency fund to put these fears to sleep.
Besides reducing anxiety, emergency funds serve a real purpose. You don’t want a financial emergency to plunge you into years of debt or rob you of your hard earned assets (like your house). When you have a real unexpected financial emergency, your fund can see you through.
A single financial emergency can do real long-term damage. A study done by The Pew Charitable Trusts showed how easily a small emergency can impact the savings, and debt of a family. The study found emergencies frequently destroy earmarked savings, and put families into inescapable credit card debt.
Don’t let this happen to you. Start saving today.
How Much Should You Save?
How much you should save is a personal decision you need to make. Here are some questions to ask yourself in determining how much to save.
- How much time would it take you to find new employment if you lost your job?
- What are your typical expenses per month?
- How much of your budget could you cut during an emergency?
Most financial experts recommend saving 3-6 months of income. But you could also quantify it as the amount of money you need to survive a period of unemployment. If you find yourself unemployed, your emergency fund must provide enough runway to find another job.
Don’t let financial emergencies ruin your future.
Over their lifetime most people make two horrible financial decisions. First, they don’t plan for retirement. Second, they carry bad long-term debt. An emergency fund can help with both of these. An emergency fund of any amount will keep from dipping into your retirement funds early, or taking on bad debt when Murphy’s law kicks in.
The $1,000 Emergency Fund: A First Step
Does this seem impossible? Start with only a thousand dollars. This is the simple first step popularized by Dave Ramsey.
The $1K emergency fund is just enough of a cash buffer to get a grip on your finances. It’s not enough money to replace a car or months of income, but it will get you through those tough moments that hurt you in the long term.
You shouldn’t have to choose between paying your mortgage and putting new tires on your car. If you aren’t used to having much money in the bank, building that $1K safety net will feel liberating.
A Full Emergency Fund
Here’s the bad news: emergency expenses often cost you more than $1K. If you typically have a few thousand dollars in your savings account, or even if you’ve just gotten the hang of keeping $1K around, saving those three to six months of income is the next step.
Once you get the first $1K you’ll be surprised how easy it is to put away more. After you save the first $1K, keep saving til you reach your goal. The more you save, the more you’ll relax.
Tom is a contributor to WealthFit. His goal is to provide a high-level glimpse into the many and varied areas of learning that WealthFit covers.