Why is it important to build your emergency fund?
According to Investopedia, an emergency fund is a financial safety net for future mishaps and / or unexpected expenses.
It’s definitely a good idea to have money set aside for tough times in a place where you’re able to get to it if you need it.
An emergency fund can be set aside to cover large, unexpected expenses, such as: major health expenses not covered by insurance, unexpected car repairs, and the biggest risk to your finances – job loss.
Why is an emergency fund important?
A properly funded emergency fund will allow you to cover expenses for several months if you lose your job, or if something unexpected comes up that would be difficult to cover within your normal monthly expenses.
Besides providing a safety net, your emergency fund is also an excellent way to protect your savings and keep you from going into debt.
The Right Mindset
The hardest part about building an emergency fund is deciding to get it done. Once the decision is made, it’s pretty straightforward.
Saving up a few months’ living expenses can feel overwhelming, especially if you’re starting from scratch.
Are you a saver or a spender?
It is all about finding a process that works for you. Start by saving $100 per week. If that’s too much, save $50 and build up from there. Once you become a saver, it is hard to go back to being a spender.
Your focus is on finding ways to make it work… not why it won’t!
How much should you keep in your emergency fund?
Let’s break your emergency fund into two phases. The first phase is to jumpstart your fund with a minimal amount. Your goal should be to aim for $1,000 within the next 30-60 days.
Now, remember… you’ve already decided that getting an emergency fund established is something you’ve already decided to do. So, now your focus is on finding ways to make it work!
Phase 1 is designed so you have a little cushion in case something comes up, so you won’t have to go into debt.
Once that’s accomplished, the next step is to take care of any outstanding debt .
After your debt is completely eliminated, you can focus on getting your emergency fund fully funded.
Phase 2: The ultimate goal for your emergency fund should be to cover unexpected expenses. While the size of your emergency fund will vary depending on your lifestyle, monthly costs, income, and dependents, the rule of thumb is to put away at least three to six months’ worth of expenses.
The more stable your income and household, the less you may need in your emergency fund. One way to look at it is how long would it take for you to find a comparable job if you lost the one you had. And if you work for the government with very low probability of losing your job, you may not need to keep as much set aside.
Finding extra money to fund it
Finding extra money to meet your financial goals always comes down to 2 things:
- Spending less
- Earning more
If you’re going to start off spending less, here are some ideas on how to make that work:
Track everything you spend, what you bought and how much… write it down; rate it on scale of 1-10, with 10 being you absolutely NEED it. Anything lower than a 10, don’t buy it today.
If you generally eat your meals out, brown bag it for the next month or two. Same with your coffee. Brew it at home and bring it with you. Just for the next 30-60 days. Not forever, just until you reach your e-fund goal. It’s that important.
What are your typical bills? Is there anything you can do without for a month or two or three? Put your cable bill on pause? Put a moratorium on shopping? Get creative. Do something today that your future self will be super proud of!
It’s time to prioritize and determine what’s critical to your long-term financial well-being.
Maybe it makes more sense to find ways to earn money. You can make a game of it. You win every time you add to your emergency fund.
Here are some ways to earn more:
- Getting a raise or a better job (ideal for the long term!)
- Getting paid overtime at your current job
- Taking on a part-time or temporary job
- Doing extra work on the side (side gigs like dog walking, baby sitting, etc.)
- Selling things you already own (garage sale, ebay, amazon, etc)
An emergency fund is not an investment
Find someplace safe without fees. The goal is not necessarily to make money on your e-fund.
You’re looking for very little risk so that you can be 100% sure the money will be there when you need it. It’s to prevent you from taking on additional debt and providing safety to you and your family.
- An emergency fund should strike a balance between earning interest and allowing easy access to money.
- Stocks are not the place for an emergency fund. They can be volatile, and selling them in an emergency can lead to a loss.
- A checking or money market account with check-writing privileges might make sense.
Your peace of mind is more important than the return on your money. You can also look into:
- High-Yield Savings Accounts.
- Money Market Accounts.
- Certificates of Deposit (CDs)
- *Roth Individual Retirement Account (IRA) with very low risk instruments
As your emergency fund grows, you may want to consider a combination of these.
Again, your emergency fund is not an investment. It’s insurance with one purpose… to protect you and your family. You want something that has no risk. You want to make sure the money’s there when you need it!
What does a financial emergency look like?
Job loss is usually the primary reason you need an emergency fund—and for good reason. You have to have a stash of cash to pay for things if you’re no longer receiving a regular paycheck.
You want the fund to be big enough to cover several months of bills while you look for a new job.
Also, you will want your fund to cover the possibility of any medical emergencies, paying for home repairs due to a natural disaster, unforeseen vehicle repairs, etc.
What do you do with your money after your emergency fund is completely funded? Congratulations!
After you’ve set aside a portion of your budget for living expenses, here are a few savings goals to work toward.
- Save for expenses that are 1 to 5 years away… a new car; down payment on your new home; vacation…
- Pay down any debt
- Protection – life insurance… are you making sure that your family is taken care of if something happens to you?
- Save for retirement …
- Put aside money for some fun.
If it takes you longer than 60 days or you have setbacks along the way, remember that you are STILL ahead of where you were when you started. Any progress is a good thing!
And once you’re done? Don’t be upset if you do have to use your emergency fund. That’s what it’s there for!
Congratulate yourself on having built one in the first place. Then use the same steps you used to create it in the first place to rebuild it again.
That’s because emergencies happen to all of us. It’s a matter of when, not if.