An emergency fund exists to help you and me handle those unexpected expenses that always seem to pop up at the worst possible time. It’s a rainy day fund and since the average person will experience a major life event in any given 10 year period, having an emergency fund in place to handle those unexpected expenses makes a great deal of sense. What things can be covered by an emergency fund?
- The car breaks down
- You lose your job
- An unexpected medical bill pops up
- The air conditioner goes out
- Your best friend wants you to attend her (surprise!) wedding out of state
- Your home floods
For the purposes of this discussion, an “emergency” is anything that is an unexpected, unplanned event. A vacation in the Bahamas doesn’t qualify as an emergency, neither does needing new tires for your car. Both of those should be “planned for” expenses. A leaking gas furnace in winter IS an emergency (in more ways than one) as is a devastating tornado ripping through your home.
In the past, you may have relied on a home equity line of credit, credit cards, or family loans for unplanned expenses or emergencies. Those options can have negative side effects – I know, I’ve used all three. Using home equity puts you in more debt (at least until you sell your home). If you use credit cards, you’re committing future earnings to current spending, and family loans can make that Thanksgiving turkey taste a little gamey. Since debt isn’t a desirable financial solution, having a properly funded emergency fund will let you to use your own savings to meet those financial challenges.
How much should be in my emergency fund?
In the beginning, work to get something – anything – into savings. Just having $500 to $1,000 in a liquid emergency fund will allow you to know that you don’t have to depend on debt or family to handle the unexpected. That peace of mind is a great relief.
The general rule of thumb is to save three to six months of living expenses in a liquid, easily accessible savings account – eight to twelve months of living expenses if you’re self-employed or the sole breadwinner. The key is to have a system of automatic savings to replenish your emergency fund in case you’re forced to dip into it. Although three to six months is the ideal cushion, it’s going to take quite some time to get to that level.
How do I fund my emergency fund?
Try using one of the 17 Sneaky Savings Strategies. There are many ways to trick yourself into saving money, which one or ones you employ is up to you. Having a yard sale is a great way to generate that extra cash.
A second job could be another option or you could ask for a raise and bank all of it (after taxes) into your emergency fund. Using one of the 26 ways to make extra money to capitalize your emergency fund could help you get to that three to six month level as well.
The biggest obstacle to saving is not being in the habit of saving, so take steps to pay yourself first. Set up direct deposit from your paycheck to a savings account, an interest bearing checking account, or a money market account. This accomplishes two things:
- You fund your emergency fund
- You’re forced to live on less than you make
Where you park the money is up to you. Whether you keep it in an interest bearing checking account so you can just write a check when an emergency bill comes due or move the money to a higher yield account (such as a 30 day CD) for the interim, using self discipline you have inside yourself to set that money aside so it’s there when you need it is critical.
If you don’t have an emergency fund in place, or if your emergency fund is weakened, get back on track and get your emergency fund fully capitalized now!