There is nothing more distressing than when you find out you’ve lost your job. Or perhaps there’s a large medical bill that suddenly came up and you don’t know how to cover it.
Whatever the scenario, an emergency fund offers you a safety net in times you need it most, allowing you to sleep easy at night, knowing that you are prepared for the worst.
Coming up with an emergency fund may not be easy for many. It requires intentional planning and discipline.
In this article, we’ll go through some of the critical aspects of an emergency fund. We’ll cover topics such as what is an emergency fund, why you need it, and how to build one.
What is an emergency fund?
First off, what is an emergency fund exactly? The emergency fund definition is simply easily accessible funds stowed away for the purposes of unforeseen circumstances. Examples of unforeseen circumstances can be an illness, job loss, or critical home repairs.
The key to an emergency savings fund is that it is easily accessible. After all, emergencies are, by nature, unexpected future events. Access to those funds, therefore, needs to be available at a moment’s notice.
Where to park your emergency fund
The most common form of an emergency fund is cash in a high-yield savings account. An emergency fund savings account is easily accessible and virtually no risk.
Alternatively, money market accounts are also easily accessible with potentially higher interest rates than a savings account. Just be aware of the fees that may come with money market accounts.
Certificate of deposit (CDs) offer higher interest rates than a savings account. However, you’ll need to pay a withdrawal penalty if you need access before the CD matures. One way to get around this is to invest in several different smaller CD term lengths, all maturing at various intervals.
Another option is to utilize your Roth IRA for your emergency fund. You can take out contributions you’ve made to your Roth IRA without additional penalties or fees. However, withdrawals on any earnings will come with a 10% penalty. Access to your Roth IRA funds is also not immediate, often taking several days to withdraw.
Having your emergency funds tied to stocks, mutual funds, or bonds is generally not advisable. These long-term investment vehicles are riskier as they are prone to the ups and downs of the stock market. You don’t want to be caught with little to no funds when the markets are doing poorly.
How much to put in your emergency fund
The general convention is to have at least three to six months of living expenses covered in your emergency fund. Some factors to consider when calculating how much to save:
What your total monthly expenses are
What is your local job market like (i.e., how easy is it to find a job?)
Existing savings or liquid assets
Months of unemployment
Why you need an emergency fund
An emergency fund is beneficial for a number of scenarios. Below are just a few reasons why you’ll need an emergency fund.
Needless to say, losing your job can be a huge financial burden. With the immediate expenses not going away, an emergency fund can help alleviate these financial obligations.
Depending on the local job market and field of work, job loss can be an inevitable scenario. You must prepare for the worst-case scenario and not rely on company benefits like severance or termination packages.
For those located in areas prone to hurricanes, earthquakes, tornadoes, etc. it’s wise to have a bit of money saved up to help cover costs. Insurance helps to cover most major items, but to have some extra cash for things like clothing, blankets, food, and other miscellaneous expenses will help out tremendously in the recovery efforts.
An unexpected illness or medical procedure can set you back from work for an extended period of time. On top of the medical bills, you’ll need to consider covering your monthly expenses. It can be quite overbearing balancing your illness with your financial responsibilities if you don’t have an emergency fund in place.
With the everyday wear and tear of vehicles, failure is bound to happen. Whether it be engine trouble, transmission problems, flat tires, or alternator failure, car repairs are not cheap.
Like car repairs, you never know when a major appliance or component of the home may need repairs. Plumbing, electrical, HVAC, and roofing can all be susceptible to damage at some point.
Condo owners can be hit with thousands of dollars in special assessment fees to help cover condo maintenance and repairs. For instance, if a pipe breaks and the condo’s building reserves can’t cover it, management will invoke an assessment fee on all owners within the condo building. It doesn’t matter whose fault it is, you’re still on the hook.
Medical bills can range from ambulance rides, to treatments, and to medication. All of these bills add up. If you’re not covered by your insurance, medical bills can come with a hefty cost. Build up an emergency fund to cover some, if not all, of these bills.
How to build an emergency fund
Saving money for emergencies requires careful planning. Without intentional planning and thought, it can be all too easy to neglect this essential fund. Follow the three steps below to learn how to build an emergency fund.
Calculate your monthly expenses
To start building an emergency fund, you’ll first need to figure out the exact amount to save for. Go through your monthly expenses and add up all the necessary items. These expenses can include:
Credit card payments
Car maintenance & gas
Cell phone bill
Entertainment subscription fees
Decide how much to set aside
Now that you have a picture of your monthly expenses, you’ll need to decide how much you want in your emergency fund. As mentioned, covering three to six months of monthly expenses is generally recommended.
Whether it’s three or six months, it ultimately depends on you and your circumstances. For instance, if you believe you possess skills that are high in demand and unemployment is low in your area, you may be fine with three months of savings.
Perhaps the economy is weak and jobs are scarce. In this case, you may require six months to up to even a year’s worth of savings. Whatever the circumstances, decide how much to set aside based on your comfort level and analysis of your situation.
The final step is to finally start saving. Obviously, three to six months’ worth of savings for an average American is no small amount.
In fact, according to stats from the US Bureau of Labor, the average expenditures for an American consumer is $61,224 in 2018. That’s just over $5K per month in expenses for the average consumer. To save three to six months for an emergency fund means slotting away a total of $15-30K!
This amount may seem like a daunting figure, but it can be done. All it takes is a little patience, discipline, and self-sacrifice, and you’re well on your way to having a decent-sized emergency fund.
Tips on how to save for an emergency fund
There are a plethora of ways on how to save for an emergency fund. Most people don’t realize how easy it is, but it does take intentional planning.
Below are some recommended emergency fund tips:
Slot away money regularly: It is obviously quite difficult for the average consumer to come up with $15-30K immediately. Instead, allocate small amounts of money on a regular interval into your emergency fund. Think of it like a recurring payment, no different than making credit card payments.
Utilize your tax refund: It may be tempting to spend your tax refund on a luxury item, however, consider using it for your emergency fund instead. Tax refunds can be fairly sizable, so the time needed to save for your goal could be cut down considerably.
Save your next bonus: Similar to the tax refund, if you simply save your next work bonus, you’ll reach your emergency fund goal much quicker.
Plan a “staycation”: Instead of burning thousands of dollars on a two-week vacation at a resort, plan for a staycation instead. You might not experience the gorgeous sun or sandy-beaches, but at least you’ll get some rest and save significant amounts of money in doing so. Plan for that dream vacation once you reach your emergency fund goal.
Dining in: Staying home to eat rather than going out would cut down on food expenses. Put the money you save in the emergency fund.
Downgrade phone plan: You most likely don’t need a massive data plan with unlimited features. Wait till you reach areas with Wi-Fi to reduce your data consumption. This can help shave $20-30 off your phone bill each month.
As you can see, an emergency fund acts as a safety net for when you most need it. Unexpected events like disasters, job loss, or illness happen to the best of us. With careful planning, you can build an emergency fund that will carry you through these unforeseen scenarios.
When it comes to your personal finances, we can help. It’s our job to give those in debt the means to climb out of the hole and take back control. CreditAssociates offers a confidential free consultation to help you meet your financial goals, contact us today!