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An emergency fund is cash set aside for what I’ll call a rainy day. Times you’ll need to rely on these funds include:
- Medical expenses
- Home repairs
- Car repairs
- The loss of your job
Your emergency fund is NOT an account to touch for a new tv. Or for a down payment on a car that’s out of your means. Renovating a bathroom in your home? This account should not be used. It is there for essential, unexpected expenses.
Why It’s Vital To Have
If your furnace/AC stops working, how will you afford to replace it? How about your cars transmission breaks and that’s your transportation to work? Or the worst case scenario, you lose your job. How will you pay the bills so you keep your home and put food on the table?
Your emergency fund is a self grown “insurance” policy in place to help pay for unexpected expenses. Sure, you might have credit cards but do you really want to pay 18% interest? What if your credit score is low when you lose your job? You could have issues getting approved for credit. Did you know that banks can decrease your credit card limit? They can also take away available balances on your home equity line of credit. If credit is your emergency fund, think again.
How Much To Save
6 months of all expenses is the general consensus. Refer to your budget and add up your total monthly expenses. Make sure to include your bills, groceries, gas and any expenses that are essential. If your monthly expenses are $2000, you’ll want $12,000 in your emergency fund.
Building An Emergency Fund
Six months of expenses is a big number and I get that. The trick is to save something. Start with $100, then get to $500 and eventually you’ll reach your goal. You’ll thank yourself the first time you need to dip in.
Step 1. Figure out your essential monthly expenses. These are expenses that are absolutely necessary. You don’t need to include expenses such as eating out or coffee since those could be removed if needed. The best place to figure out this number is your budget.
Step 2. Determine how much you can save on a monthly basis. Starting small is ok but if it will take you 10 years to get to your goal, there’s a problem. You might be spending too much or have too much debt. Make every attempt to adjust your budget so more goes into savings.
Step 3. Setup how you’ll save your money. Automated savings plans are key. Some banks will even setup your automated transfer when you get a deposit of a certain dollar amount (pay day for example).
There are several apps that now let you round up your debit card purchases to the closest dollar. The difference from your purchase price to the next whole dollar is then saved. I love this strategy and find it to be one of the easiest ways to save.
Separate your emergency fund from your primary checking. By keeping your emergency fund at a separate bank, you won’t see the account every time you view your checking account online. This removes some temptation of using the account for non-essential, unexpected expenses.
Step 4. Finally, your finances change all the time and so will your emergency fund. It’s important to periodically review your expenses and adjust your savings accordingly.
If you don’t have an emergency fund currently, you’re not alone. According to the Federal Reserve, 39% of Americans would have an issue affording a $400 unexpected expense. The important thing is to start saving today!