What Is an Emergency Fund For?
An emergency fund amount is to help when life hands you the unexpected. Bad luck, miscalculation or unfortunate circumstances can take a toll on the strongest of budgets and finances. An emergency fund can help with:
Unexpected job loss can happen to anyone. Job security is something we hope to feel no matter where we work. Even if you aren’t fired or laid off there are other factors outside your control that can affect your employment status:
This is just a partial list of the many variables that could contribute to your loss of employment. Ask yourself how prepared you are to keep up on monthly expenses in the event of sudden unemployment. Surveys taken of average Americans revealed the majority don’t have even $400 in savings. If you take away your main source of income, you can’t get very far on $400 or less. You’ll need a larger emergency fund amount.
Medical, dental and veterinary emergencies can happen in the blink of an eye and most cannot be anticipated or avoided:
It’s important to understand what would happen to your finances if you have a $1,000 or more of sudden and necessary expenses. This is one of the biggest uses of an emergency fund amount.
Unexpected Home Repairs
All it takes is one good rain or windstorm, nearby wildfire or blizzard for your home to need a major repair like:
Many of these issues would make a home unlivable until they’re repaired. This would mean the extra expense of a hotel stay until you make repairs. Do you have an emergency fund amount to cushion or absorb such costs?
Unplanned Travel Expenses
If a loved one gets sick and needs help, can you afford the time off work and the travel involved? Many people cannot. Travel expenses could also apply to emergency evacuations.
It is important to note that we are not talking about any travel expenses. For example, a trip to London for a week-long music festival should not come out of your emergency fund amount. Trips of a recreational nature should be saved for separately and after your emergency fund amount is healthy.
A recent study found that most Americans are under prepared for an emergency and took on the following hardships as a result:
These statistics don’t include the millions of people that turn to high-interest credit cards in times of emergency. In doing so, people are living beyond their means, and many incur late and missed payment penalty fees, worsening an already precarious financial situation.
Calculating the Appropriate Emergency Fund Amount
So, how much should be in your emergency fund? We recommend starting at $1,000. You may need to temporarily reduce your expenses to get there, but the sense of security is worth it, as most small emergencies that come up can be covered with this amount of money.
Beyond the $1,000 you should save six months of monthly expenses. Consider the following when calculating your monthly expenses:
Don’t include expenses you could shave off in the event of a prolonged financial burden. In the event of a job loss or medical issue you could forgo:
Once you’ve calculated your minimum monthly expenses, multiply that number by six—that’s your magic emergency fund amount number. Don’t feel overwhelmed. Anything is better than nothing and we’ll help you get there, dollar by dollar.
Starting Your Emergency Fund
If your monthly expenses are $2,000, your needed emergency fund amount is $12,000. That can seem like an impossible task, but it isn’t. Rome wasn’t built in a day and your emergency fund won’t be, either. We’ll help you get started with small steps and achievable goals.
Open the Account
It’s important to put this account in a place you won’t see it. If you use mobile or online banking, we recommend either asking your bank to keep this account off your login screen or opening an account at a different institution.
You want to have easy access to this account in an emergency, but not so easy you’re tempted to spend it on a whim. Opening an interest-bearing money market savings account (MMS) is a great option. With an MMS you have limited withdrawals available or you convert to a lower interest-bearing account. MMS accounts typically require a higher minimum balance to avoid a monthly fee.
Because incurring a new monthly fee goes against everything we’re trying to do here, we recommend beginning with a standard savings account. These need only $500-$1,000 to avoid a monthly fee, so once you have the required minimum, open the account and start feeding it.
Starting to Save
There are a few painless ways to start your emergency fund. If you carry cash, every time you come home at night, clear your wallet of all its ones and fives. If that hurts too much, start with ones.
If you don’t carry cash, you can look at your checking account every night and round down to the nearest 10 dollars. Transfer the difference to your savings account. For instance, if your account ends the day at $387.55, you would transfer $7.55 to your savings. You can round to the nearest 5 dollars, making it $2.55 in this example, if the first number is too high.
If you saved this $2.55 a day, five days a week for a year, you would have $663 dollars at the end of the year without really trying. Multiply that by two if you’re a two-income household and you’re over $1,300.
Find the places in your monthly expenses where you could do something yourself instead of paying someone else to do it for you. If you have a gardener or housekeeper you pay $60 a month, cut that expense and do the work yourself. You can put an extra $720 per year toward your emergency fund amount. Now you’re at $2,046.
Do you eat out once a week? Try cutting back to every other week or pick a less expensive restaurant. If you normally spend $50 a week on dining out, and you can cut it in half, you’ve added another $600 to your growing fund. Now you’re at $2,646.
Start a Savings Routine
Now you’ve cut back a little and transferred your daily change to an account. What are you left with at the end of every month? If you can afford $100 a month toward an emergency fund, you’ll add $1,200 a year, bringing your total to $3,846 in savings a year.
At that rate, you’ll meet your goal in three years and one month. Not bad! Each year you save, you’re buffering yourself against financial hardship by two months.
No matter what you can save a month, anything is better than nothing. Never talk yourself out of saving because you’re only able to put away $10 one month—that is better than saving nothing. Once you have your emergency fund, you can start indulging in your creature comforts again or start another savings account with a new goal in mind.
Emergency funds can save you from financial ruin, but they take planning. They also give you peace of mind and reduce stress on a daily basis because you know you’re operating with a solid safety net. A fund will also keep you from spending on a whim. If you take our advice and make this account separate, you won’t see a surplus of money and convince yourself you can go a little overboard for Christmas this year.
An emergency fund keeps your finances healthy even when large, unexpected expenses barge into your life. In an emergency, you won’t feel pressure to spend on credit or borrow against retirement and incur all the fees and penalties that come with both. With the small achievable steps we’ve provided you, there is no reason you can’t start your emergency fund right now. Happy saving!