Continuing the finance 101 blog posts, I want to take a moment to talk about emergency funds. There has been a lot of talk with the ongoing public health crisis about people glad they had or wishing they had emergency funds. Emergency funds are one of the first goals people set after they pay down high-interest debts, like credit cards. There is a bit of confusion on what an emergency fund is so I’m hoping to clear that up in this post, along with highlighting why they are so important.
Emergency Fund VS Savings
Emergency funds are not the same as savings, though your both can be stored in an interest bearing savings account. The difference is that savings are funds you put away to cover expected expenses or planned expenditures. This is the annual insurance payments, car repairs, work boots, or items you are saving up to purchase like a kitchen aid mixer or video game system.
Emergency funds are for the things you don’t expect or plan. This is a seperate amount of money that doesn’t get touched unless an emergency occurs. Emergency funds are the I lost my job, ended up in the hospital, or freakish bad luck incidents funds.
How much should be in an Emergency Fund?
The amount in an emergency fund depends on your own spending habits. Take your monthly budget and knock it down to the bare bones. I mean really cut it to the point of survival expenses only. This can include rent/mortgage payment, water, heat, electricity, internet (because if you lost a job you need to find a new one), and 59 cent ramen-level eating. Now take that money and multiply it by 3.
That is the goal amount you want in your emergency fund. Three months of expenses. If you want to be proactive, you can up that to six months of expenses.
Why have an Emergency Fund?
Because emergencies are stressful. It doesn’t matter what kind of emergency, your stress levels are going to be through the rough. Do you know what makes situations even more stressful? Not knowing if you can afford to keep a roof over your head or your family fed. With an emergency fund, those worries can take a back seat to the actual emergency. It gives you time to figure out the situation before it goes from bad to dire.
How do you save up an Emergency Fund?
You don’t have to do it overnight. A way to start is to set aside a small amount of money each paycheck to put into a savings account or if you don’t have a bank account, a jar you can put money in but not get it out. Even if it is $20, it will slowly begin to add up. The real struggle is that you want your emergency fund accessible in case of an emergency, but not so accessible that you are tempted to spend it. Most importantly, never put your emergency fund into any kind of investment! The whole point of an emergency fund is that it is liquid and readily available to you. If an emergency happens, you don’t want to worry about how the stock market is doing or the fees you may need to pay to get access to your money. A simple savings account with a good interest rate is all you need. If you know you are a spender, maybe have the savings account at a different bank.
Emergencies can and will happen. An emergency fund can help you feel more secure and less stress by knowing you can (usually) survive what life throws at you!