Picture this: A warm July afternoon, you and your family have packed up the car for a trip to your parents’ house for the weekend. Along the interstate, an unfamiliar smell creeps up your nose. Your dashboard window reveals white exhaust swimming into the air—the realization hits you that the engine has died.
This $2,000-3,000 expense could be detrimental, but with a fully funded emergency savings account, you and your family will still be on track to continually meet your financial goals and avoid debt.
What is an Emergency Fund?
An emergency fund is an account set aside for any perilous event life throws your way—major car damage, natural disasters, home repairs, personal injury, job loss, etc.
Emergencies tend to appear when you least expect them, or (more often than not) when you are least prepared to handle them. Having a reserve of money set aside for times like these will help to reduce the stress incurred by situations such as this.
Emergencies, though unpredictable, do happen and they can be accompanied by a hefty price tag. Establishing a healthy emergency fund can ward off one major financial detriment: debt. Going into debt isn’t a wise long-term solution for many, and having an emergency fund can help keep that malady at bay. By having this fund, you put yourself in the best place to remain debt free and ensure financial security in times of crisis—not simply staying afloat, but wading with more stability through tough waters.
How Much Money Should Be Saved in an Emergency Fund?
According to a 2012 study, 56% of Americans do not have a fund that would cover 3 months of living expenses. Over half of Americans today are not financially prepared for an emergency situation.
Financial planning experts advise that you should have anywhere from 3 to 12 months of your living expenses saved in an emergency account. The importance here is having a back-up plan that will allow you to go about your daily life while you work to fix the unexpected turbulence in your path. The best way to start is to calculate your monthly expenses—mortgage, car loan, tithes, groceries, utilities, school, and any other necessary payments. After gaining a realistic sense of your monthly spending, you will be better-informed of the specific dollar amount to add to your fund.
3 tenets of a healthy emergency fund:
- Liquidity (ability for assets to be converted to cash)
- Accessibility (ease of receiving funds)
- Low Risk (security of funds)
It is good to think through the best-practices for curating the most reliable and available emergency account that you can. Keeping your emergency fund in a secure bank account is a great way to ensure safe and fast accessibility to the funds should you need them. A money market account, which has a slightly higher interest rate, is also a good option to consider.
Start Slow, Build Steadily
Rome wasn’t built in a day, and you should view your emergency fund the same way. It is important to financially prioritize your saving habits. Creating manageable long-term savings goals will make your foundation strong and give you something to add to over time.
If something should happen and you feel it’s best to use your emergency account, be sure to also have a plan of action for replenishing the account overtime.
Out of Sight, Out of Mind?
Your emergency money should be stored in a bank account separate from your traditional account. This separation will guard you from the temptation to dip into that fund for any recreational or daily uses. Remember, this account is for when life throws you a curveball, and take that seriously in considering when to use the money from that fund.
Emergency situations look different to everyone, therefore the best way to determine a situation that would lead to using your emergency fund can be ascertained by thinking through these three questions:
- Is it unexpected?
- Is it necessary?
- Is it urgent?
These questions can help guide your decision about using the money allocated in your emergency fund.
Even though you may not see your account daily, it is important that it does not simply remain ‘out of mind’. It is important to examine all of your financial practices to see how an emergency fund will fit into your long-term financial goals?
Is There a Right Answer?
The short answer is no. There is so much variety in ways to create and sustain an emergency fund. Some important life factors to consider:
- Job Stability
- What type of industry are you in?
- How steady is your income?
- Family Responsibilities
- How many dependents do you have?
- Planned Big Spending Projects
- Medical Bills
- New Baby
- Tuition Costs
- Caring for Aging Parents
Considering the nuances of your daily life and financial obligations can help inform your saving regiment and the best way to plan for committing to an emergency fund.
Think about that family driving at the beginning of this piece. They were placed in a stressful situation, and they had a plan for action, which relieved stress and led to growth for the future. That is an example of why it is so important to create, and if absolutely necessary, use your emergency fund.