Even after I learned what an emergency fund was, I had difficulty knowing how big it should be, how one goes about saving up for the fund, and when it should really be tapped.
You see, an emergency fund sounds basic and simple until you start living life. Then it quickly becomes much more complicated!
Are you as lost as I was years ago? You don’t have to pretend to understand emergency funds, because today is emergency fund 101 and we are going to cover all you ever need to know!
What an Emergency Fund Is (and Why You Need It)
Since this is “Emergency Fund 101”, let’s start at the very beginning and talk about what an emergency fund is (and why you need one).
As the name indicates, an emergency fund is a pot of money you have in order to handle unexpected emergencies. After all, you never budget for emergencies because you don’t know what they’ll be, when they’ll happen, or how much they’ll cost.
That’s exactly why you need an emergency fund – your budget can never anticipate all the things life might throw your way. When life throws you curve balls and you don’t have an emergency fund, you’ll have to turn to loans, credit cards, or payment plans.
These aren’t necessarily bad options, but you’ll pay more money in interest and financing fees than you would by using cash out of your emergency fund.
Here’s an example. Let’s say you’re married with small children. You only have a small budget for eating out, which amounts to one meal out a week.
You come home from work one night and begin to prepare dinner. You open your 2-year old refrigerator door and notice the refrigerator obviously stopped working during the day. All your food is warm!
Without an emergency fund, you’ll have no money for an immediate replacement. You’ll end up financing the replacement, which will cost you more in the long run than paying in full with cash.
Your other option is to save up for the refrigerator, but that might take a long time. Nevermind you can’t afford to save up for a replacement while eating out every night – something that also isn’t in your budget.Emergency funds are staples in every #financial plan for a reason! Everything you need to know: Click To Tweet
Where Should it Be?
The thing about an emergency fund is you might need it quickly. You could end up costing yourself extra money if you don’t have your money readily accessible.
Let’s re-look at the refrigerator example. If your emergency fund was tied up in a CD, you might have to pay fees to access your money in order to buy a new refrigerator. If your “emergency fund” was in the form of a sellable asset (like a car or land), you wouldn’t have access to it until you could sell it. In the meantime, you still have no fridge and you have to eat out.
There’s no need to get fancy or creative with where you put your emergency fund. A savings or checking account at any bank will work just fine. Some people actually combine their emergency fund with their normal, every day bank account. They use a spreadsheet that lets them know how much of their savings account is for their trip to Cancun versus their emergency fund.
On the other hand, if you’re prone to temptation, you might be better with the out-of-sight, out-of-mind approach. You could open up a separate account you transfer money to regularly. It’s still an accessible account, but you don’t normally use it to pay bills or cover your shopping trips, so the large balance isn’t justification for an otherwise out-of-budget shopping spree.
(Tip: It could be a good idea to open a savings account at an online bank, or a different bank than the one you normally use. This makes it a little “harder” to get to.)
How Much Should You Save?
Now you know why you need an emergency fund and where to put it. The next step is knowing how much should be in the emergency fund.
Here’s my opinion: there’s no one-size-fits-all answer. $1,000 is a common suggestion, and it’s a good start, but it’s just a start. In the end, you need to take a look at your life and what risks you have.
Someone who has three small children, a home, and a long commute probably needs a bigger emergency fund than someone who is single, walks to work, and rents an apartment.
That’s why another common suggestion is to work up to around 6 months of your necessary living expenses; this is based more on the requirements of your life, unlike the flat-rate $1,000 suggestion.
Necessary expenses are the expenses you’d still have to cover even if you lost your job tomorrow (which would certainly be an emergency). If you’d cut eating out, clothes shopping, and reduce your grocery bill, take that into account.
Not everyone will be comfortable with a 6 month emergency fund. Remember, this is only a suggestion. If you work in a very volatile industry or have a risky profession, you might decide you need to save up more to have more peace of mind.
For example, if you’re a police officer, you might be concerned about the danger of your profession, which might lead to being unable to work for an extended period of time. In this case, you might want to have a more robust savings plan.
(Side note: those in risky professions should thoroughly investigate company disability benefits. If your company doesn’t have great benefits, this is something you should consider purchasing on your own.)
After you’ve saved several months worth of living expenses, you’ll probably want to change course on where your emergency fund is stored. Keep a few thousand dollars readily accessible in checking or savings, and let the rest of your money work for you through investments or higher-interest accounts.Not sure how much to save up for an emergency fund, or when you should use it? Answers revealed here: Click To Tweet
How to Save up for an Emergency
You might be panicking at the thought of saving tens of thousands of dollars. Whoa, back up! Remember you just have to start with $1,000, which might be pretty easy to come up with. You might get that much in this year’s tax return! You could sell some clothes, books, and furniture.
Whether or not you’re easily able to achieve a $1,000 emergency fund, you’ll have to change tactics eventually. After all, you can’t build up to 6 months of living expenses by depending solely upon a tax refund.
At some point, you should include emergency fund savings in your budget. Yes, that might mean you have to cut back in other areas. The alternative is finding more income. Ask for a raise, switch to a better-paying job, or take on a second job (sometimes called a side hustle) in order to pad the account.
Do you know how to eat an elephant? One bite at a time. Don’t rush to fully fund your emergency fund in a few months. Decide how much you want in the account, set some milestone goals, and then attack it.
For example, if you want your emergency fund to have $15,000, you could set a goal to have the first $1,000 in two months. Then you could aim to have $5,000 in the account after the first year and the account fully funded in two years.
When You Should Use It
You experience a tire blow out on the way to work. Obviously, you need at least one new tire. While visiting friends out-of-state, you break your ankle and get charged out-of-network costs for your emergency room visit. Your dog eats a diaper and needs to be rushed to the vet for a possible intestinal blockage.
Which of these are emergencies? Can you use your emergency fund to cover them?
An interesting phenomenon seems to happen to people who are able to fully fund their emergencies funds: they don’t want to touch them for almost any reason.
That’s fine, until they start to pull out a credit card for something they’ve already saved up cash to pay. It’s silly. Give yourself permission to touch your emergency fund! You can and should use your emergency fund for any necessary, unanticipated expenses.
However, don’t use them for silly things you could have planned for, such as needing a new dress for a wedding you were asked to attend. If you have other dresses in your closet, it’s not an emergency.
Once you tap into your emergency fund, you’ll need to have a plan to replace the funds that you used. If you’re still building up your fund, you have a couple of options.
You can continue to save, just as you had been budgeting to save. Or, because you had to tap into your fund, which set you back, you might need to make an adjustment to help you catch back up. If you had a fully funded emergency fund, you’ll now need to adjust your budget to account for rebuilding your fund.
Emergency funds are one of the basic, fundamental building blocks of a healthy financial life. Don’t overlook them, build them slowly and steadily, and tap your fund judiciously.
If you have an emergency fund, what things have you used it for? If you don’t have one, what will you do to get one started today?