Emergency Funds 101 – Why You Need One and How to Grow It
Emergencies happen. There is no way around it. You may get into a car accident that leaves you out of work for an extended period of time or you may be laid off for a variety of reasons. Emergencies are unexpected events. While we don’t plan for them to happen, we know that it is inevitable and an emergency will occur at some point.
Preparing for an emergency is key to good financial health. By having an emergency fund in place you will be prepared for those unexpected moments and won’t end up in financial ruin because of it.
What exactly is an emergency fund?
An emergency fund is money that you have set aside for those unknown events. This money should be easy to use meaning you do not want it tied up in the stock market. It should be in a savings account or a money market account that can be easily accessible.
Saving for emergencies should be part of your budgeting process until it is fully funded. You will also want to decide what events are considered an emergency for your family. By knowing exactly what events your family deems as an emergency you will not be tempted to use the cash to go on vacation or go out to dinner.
Here are some emergencies you may face in the future
- Job loss
- Medical emergency
- Natural disaster
- Death in the family
- Unexpected home repairs
- Unexpected car repairs
While unexpected home repairs and unexpected car repairs both made the list of potential emergencies please note that you should also have sinking funds for both home and vehicle repairs. The sinking funds would cover something expected like the washing machine needing repair or new tires for your car. An emergency fund would be used in unexpected situations like flooding in your home or a car accident resulting in major car repairs.
Why is an Emergency Fund Important?
An emergency fund provides financial stability that you may not have had otherwise. This account will keep you on track with your other financial goals while protecting you from the unknown.
An emergency fund helps reduce stress in your home.
When an emergency happens it is natural for your stress level to increase. If you do not have an emergency fund in place you may be wondering how you are going to cover the unexpected bills while still meeting your other financial obligations.
Knowing that you have a safety net to cover you during this time will help reduce the amount of stress you have because you are at peace knowing that everything will be paid for without incurring any debt.
An emergency fund can stop you from making bad financial decisions.
When you have money in the bank to cover unexpected bills you are less likely to take out a loan to cover the repair.
Let’s use a vehicle as an example. Your vehicle starts to experience problems while driving. You take it to your trusted mechanic and are told that your transmission needs to be rebuilt to fix the problem. You have two choices – repair the transmission or finance a new car. When you have an emergency fund you will be more included to repair the transmission because you have the $3,000 cash to do so. If you do not have an emergency fund you may be more included to not deal with the problem and finance a new car because “it’s only $300 monthly”.
Your mindset changes when you have an emergency fund. It keeps you in check with your financial goals and stops you from making bad money decisions on a whim.
How much do I need in my emergency fund?
Now that you know why your emergency fund is very important it is time to discuss how much you actually need to have saved.
This is not an easy question to answer because it will vary for each family but there are some guidelines you should follow when decided on your emergency fund total.
Your emergency fund should have up to 6 months’ worth of expenses but no less than 3 months of worth of expenses.
If you are single you may want to save closer to 6 months’ worth of expenses. This will give you leeway if you lose your job or are out of work for an extended period of time.
If you are married and both work a full-time job you may be more comfortable with a 3-month emergency fund. The likelihood of both people losing their job at the same time is unlikely (but may happen if you work for the same company) so one person is still bringing in an income to cover the bills and the emergency fund is used to supplement that income if needed.
If you do not have any sort of emergency fund you should save $1,000 as soon as possible. While $1,000 isn’t a lot it is the start of a good financial foundation and can cover low-cost car and home repairs.
There is no right or wrong answer to how much you should have in your emergency fund. The amount is totally up to you and how comfortable you are with risk. It should be no less than 3 months’ worth of expenses though with a max of 6 months’ expenses.
How to Save for Emergencies
Building your emergency fund will take time because it is a large sum of money. It should be made a priority every month until it is fully funded based on the amount you have decided to have on hand.
Calculate How Much You Need to Save
Once you decide how much money you need to save for your emergency fund it is time to calculate what that total actually looks like for your family.
You will need to have your budget on hand to calculate this amount.
Add up all of your true expenses for the month. If you are out of work due to a job loss you most likely will not continue to fund your sinking funds for things like a vacation. Take this into account when adding up your true expenses.
Once you know your true expenses for the month multiple this number by how many months you would like to have saved.
$4,000 monthly true expenses x 3 months = $12,000 emergency fund
$4,000 monthly true expenses x 6 months = $24,000 emergency fund
Create a Monthly Savings Goal
Each month you should set aside a predetermined amount of money to save for your emergency fund. If there is extra money left at the end of the month in addition to this saving goal you should put it toward your emergency fund until it is fully funded. The quicker you save, the better.
Save on Autopilot
Set up an auto-transfer to save your emergency fund automatically when you get paid. This will move the money out of your checking account and into the desired savings account so you are not tempted to spend the money.
Save Any Extra Money That Comes In
If you receive a tax refund put that money toward your emergency fund. If you receive a raise at work increase the amount of money you are putting toward your emergency fund.
By saving these extra bits of money you will build your emergency fund sooner allowing you to move onto your next financial goal while protecting your family.
Adjust Your Savings Goals if Needed
Our budget changes so we should adjust our savings goals as needed as well. You will want to keep your emergency fund up to date with the current amount you are spending each month.
If your cost of living increases because you bought a bigger house then adjust your emergency fund savings goal to meet this new total.
Once your emergency fund is completely funded you can rest assured knowing that your family is protected in the event of something bad happens. If for any reason you need to use your emergency fund, start a new savings goal once you are back on your feet to replenish this account.