In this Finance Friday’s post I wanted to take a step back and shed some light on the importance of having an emergency fund and why you need one. When it comes to your finances, you should always be prepared for the unexpected, and this is why you need an emergency fund. The best thing you can do for yourself is to prepare for emergencies that require access to additional money. Having an emergency fund set aside is the ideal solution.
Financial emergencies can come in the form of a job loss, significant medical expenses, home or auto repairs or something you’ve never dreamed of. The last thing you want to do is be forced to rely on credit cards or a personal loan which could simply compound the problem.
What are emergency funds for?
An emergency fund is a stash of money set aside to cover the financial surprises life throws your way. These unexpected events can be stressful and costly.
Here are some of the top emergencies people face:
- Job loss.
- Medical or dental emergency.
- Unexpected home repairs.
- Car troubles.
- Unplanned travel expenses.
Map Out Your Monthly Expenses
Most financial advisers agree that it’s ideal to keep between three to six months of living expenses set aside in your emergency fund. This is the first step you need to consider when preparing your emergency fund. Be sure to consider both fixed and variable expenses when determining how much you need to set aside. The following are categories of some fixed and variable expenses you need to consider:
- Housing Expenses: rent or mortgage, utilities
- Insurance: life insurance, renter’s insurance, homeowner’s insurance
- Taxes: FICA and income taxes
- Debt Repayments: credit card debt, student loans, car loans
- Healthcare: health and dental insurance
- Childcare: if applicable, daycare or babysitter expenses
- Personal Living Expenses: groceries, personal items
- Transportation: gas, taxi, or public transportation
Once you’ve taken the time to calculate how much you are spending in these categories on a monthly basis, you can then determine how much you need in your emergency fund. If you are married or living with your significant other, be sure to calculate these costs as it relates to both of you so that you can accurately determine how much you need in your fund.
Start Accumulating Funds for Your Emergency Fund
If you don’t have an emergency fund set up yet, or you find it difficult to save money the key is to start small. Accumulating one month’s worth of expenses will take some time, but if you set your immediate goals to be small and manageable you will have a better chance to reach them.
The best way to get started would probably be through your bank or credit union. Open up a new savings account if you currently don’t have one and begin to save with this first. The next step is to get into the habit of making regular deposits into this account. Whether it is weekly, bi-weekly or monthly, create a schedule and stick to it. Once you make saving automatic you won’t even have to think about it.
If you feel it is difficult to begin saving simply start with a small amount. Maybe you begin with $10 a week initially. While this won’t amount add up all that quickly the important thing is to start putting something away and to make it a habit. After a few weeks, you won’t even notice that $10 missing so you can bump it up to $15 or $20 after a month or so. You will begin to get used to that money not being there and can slightly increase it again.
Set up Your Emergency Fund Savings Account
You want your emergency fund to be easily accessible at any time.
You should start with a savings account because it is simple to use and generally does not cost anything. The convenience factor is what is important when getting started. As your account grows you can find an account that earns reasonable interest so that your money is working for you. By following these three steps, you’ll be well on your way to being prepared for any situation that results in an unexpected financial loss.
Why It Is So Critical to Have Money Saved for Emergencies
- Prevents falling into debt – An emergency fund minimizes the need to use credit to pay for emergency expenses.
- Smooths out your budget – Emergency reserve fund makes budgeting easier. It does not require you to adjust your budget every time something unexpected appears
- Alleviates financial stress – Just knowing you have an emergency reserve fund allows you the peace to know that you are prepared for life’s uncertainties
- Allows for Flexibility – Emergency decisions are hard. An emergency fund allows more flexible decision-making