Simple Steps for Setting Up an Emergency Fund
When you’re working on your personal finances, one the very first steps to take is establish an emergency fund. Here, we’ll break down the basics of an emergency fund so that you can get yours rolling pronto.
What an emergency fund is:
An emergency fund protects you from financial stress when unexpected and emergent money situations pop up. It helps cover your car’s engine breaking down, furnace going out, an unexpected ambulance trip, and other similar dilemmas.
What an emergency fund is NOT:
An emergency fund isn’t a typical savings account that you regularly draw from, so stop viewing it like that right now! It’s used only in emergency situations. Otherwise you’ll constantly deplete it and won’t have anything leftover to cover expensive surprises.
First, you need to understand the difference between “emergencies” and… everything else. True emergencies require some kind of immediate action that draw from your finances. Here are some examples:
|Health or medical emergency||TV break down (unless required for work)|
|Urgent travel (think funeral or an ill loved one)||Computer repairs (unless required for work)|
|Major unexpected car, home, or appliance repairs||Vacation|
|Leaky roof||New wardrobe|
To ensure there’s always money in your emergency fund when you need it, use the account for emergency situations only.
How the size of your emergency fund. This is where it gets a little tricky because everyone’s needs are different. For instance, a two-member household will most likely need far less in an emergency fund than a six-member household.
Financial gurus used to recommend at least 3 months’ worth of expenses saved up in your emergency fund. Since the US financial crisis in 2008, most experts now recommend at least six months saved up. Regardless, it’s good to start with at least three months and work your way up to six.
Determining your monthly costs can also be tricky for some. To get a good idea, consider your fixed expenses, such as: mortgage/rent, utilities, loan payments, insurance, groceries, phone/tv/cable bills, gas, and healthcare costs. Then multiply this number by three for three months or six for six. That’s how much you should set aside, minimally, in your emergency fund.
The great debt debate. There is one caveat some people run into when establishing their emergency fund. Many financial advisors recommend first getting out of debt before starting to save. In other words, every single penny should be thrown straight at your student loan before contemplating an emergency fund.
However, if your car breaks down and you have no way to get to work and no emergency fund to make repairs, you’re going to lose your job. Therefore, you can’t chisel away at your debt or set aside your rainy day savings. So, regardless of your debt load, there should also be a chunk of change you can fall back on to get you through difficult times. Anything above this should go directly toward decreasing your debt load.
Where you should keep your funds. Your emergency fund needs to be easily accessible. Unlike investments and bonds where it could take days to weeks to withdraw funds, a regular checking or savings account is much easier to make a withdrawal.
However, you don’t want to make it too easy on yourself that you’ll be tempted to pull money out for situations that aren’t an emergency. Consider putting your emergency fund in a different account, not connected with your main finances, or another banking institution altogether in order to create a mental barrier that will deter you from misspending this cash.
How to build it quickly. Until you’ve reached your goal, treat your emergency fund like any other bill. Make payments each paycheck until you’ve reached your targeted amount. Every time you make a withdrawal to pay for qualifying expenses, return the money within thirty days, just like you would with any other bill payment.
Now that you understand the importance of an emergency fund, what it is and what it is not, and a few basic guidelines, you have all the knowledge you need to get your little nest egg started so your finances can better weather surprising or emergent situations.