Finances are different for everyone, and so are the life events we all go through. An emergency fund is your financial line of defense against life’s lemons. Although there are many financial rules of thumb, there is no “normal” way to handle your emergency fund. However, there are some answers to common questions to help you financially prepare for unexpected expenses.
What is the reason for my emergency fund?
The emergency fund is your safety net to avoid getting into a difficult financial situation due to loss of income and significant, unexpected, one-time expenses. Having one in place can reduce stress, anxiety, and other emotions that could make handling the non-financial aspects of an emergency much more difficult.
It may seem a little obvious that an emergency fund is for emergencies. However, one of the challenging aspects of an emergency fund is knowing what expenses qualify as an emergency. This fund’s sole purpose is to prepare you for costs that you cannot or would not typically plan out. For example, oil changes and new tires are vehicle expenses you know you will have at some point. However, you wouldn’t typically plan for vehicle costs that could vary widely depending on the situation. Examples of this are towing costs, medical care, and insurance deductibles you might pay in a car accident, something you would not plan to happen.
How much do I need?
How much would a new furnace cost? If you could not work, how much would you need to cover essential expenses until you could? Asking yourself these kinds of questions will help you set a goal amount for your emergency fund. The Expense Tracker can help you add those expenses up, or you can use your online banking to crunch the numbers. That exercise can also help you figure out how much you can afford to save each month as you work up to your goal amount.
The general rule of thumb is three to six months of your expenses. However, you can always start with a goal you find achievable. Say, for example, $1,000. Once you reach that goal, aim for three months of rent, then three months of the following essential expense, and so on.
How do I save that much?
Start small – If you have not started your fund, consider putting $25 from every paycheck into a savings account. You can use the Daily Savings Calculator to see the impact that even a few dollars will make in the long run. Then, check your budget or spending plan to see how much you can save after you’ve paid essential expenses and before budgeting for discretionary spending.
Keep it separate, saver – Open a separate savings account to help you resist the temptation to dip into it. Remember, this account is for emergencies, so keep it away from your daily spending accounts and separate it from vacation and holiday savings. This method will help you stay organized, visualize your progress, and provide you peace of mind.
Automate your savings: Set up a direct deposit or automatic monthly transfer to your separate savings account. Your employer may be able to take money directly out of your check and deposit it for you. Otherwise, set up an automatic transfer from checking to savings on payday. This method will help you avoid adding a manual transfer to your list of to-do’s that you may end up not getting around to doing.
Will I ever need to change the amount?
As your life changes, the amount you need in your emergency fund will change as well. It’s a good idea to revisit your emergency fund plan every six months or any time you experience a life event that impacts your income. Marriage, starting or adding to your family, buying a home, and divorce are just a few examples of when you may need to increase your emergency fund. A good savings plan can roll with the punches right alongside you!
How do I prioritize emergency savings against debt and other goals?
Deciding whether you should pay down debt, increase cash savings, or invest is all about the big picture. Since everyone has different financials, that picture will not be the same for everyone. What is going to impact you the most financially? Paying down debt and saving money long term or having a plan B that allows you to keep making minimum payments if you lose income? There is no right or wrong answer. Perhaps a good compromise is to have one month’s worth of minimum credit card and loan payments before you start to pay down debt or invest aggressively. You will have peace of mind knowing that you won’t fall further into debt or face collection action, and you will have started your path to being debt-free!
Your emergency fund is there to help you expense the unexpected. So make a plan and use the above suggestions to be ready for whatever comes your way!