Building an Emergency Fund
Who needs an emergency fund? Short answer, everybody! An emergency fund is an account that is earmarked for emergencies ONLY - Christmas shopping doesn’t count! We have all had emergencies come up that have left us wondering where we will get the money to cover the expense. An emergency fund will give you peace of mind knowing you have the money to cover things like a new AC unit, car repair, roof damage, or a layoff.
How much do you need?
The general rule of thumb is 3-6 months of expenses. When deciding if you need 3 months or 6 months you need to consider a few things:
1) Are you a one income or two income household?
2) How long would it take to replace your income if you lost your job?
3) How secure is your current employment?
4) Are you self-employed or paid commission only?
If you are a dual income household with two stable incomes, you should be fine with 3 months. If you are a single income household, incomes are not stable, you are worried about a layoff, or replacing your income would be difficult, it would be wise to aim for 6 months. Essentially, the more volatile your income is the more you need in your emergency fund.
You also need to consider your comfort level. If you fall in the 3-month camp and the math works out to $15,000 but you still are uneasy and would feel better with $20,000…then increase to $20,000. Be careful though. Don’t hoard money in this account and forget to fund other goals.
Where to keep it
Money in an emergency fund needs to be easily accessible and safe, this is not an investment where you are looking for returns. You want to be certain the money will be available when you need it most.
It is important to keep this money in a separate account away from the money you use on a regular basis. It is far too easy to dig in to your emergency fund if everything is in one account. At the very least, open a new account and name it “Emergency Fund”. Better yet, open this account at another bank where you do not see the amount every time you log in to your online account.
A great place to build you emergency fund is in a money market or high yield savings accounts. These accounts will offer a higher interest rate than your typical savings account while keeping your money safe. You can find an account that has check writing privileges (money market accounts) or link your checking account and transfer the money when you need it. Another option, but be VERY careful with this, would be to use your credit card and pay the bill out of your emergency fund account.
You can open one of these accounts at your current bank or shop online for the best rate. Click here for some top-rated accounts. Be sure to click on “Offer Details” and check the fine print.
How to start
As I mentioned above, I like the idea is to keep this money separate from everything else. Once you open a new account (or designate an existing account), set up an automatic transfer every time you get paid, and start funding the account!
If you are like me, you spend a lot of time thinking and planning about the best way to do something, which can be great at times…but many times more planning just delays you. The best way to hit your goal is to start now!
If you are thinking, “I don’t have any money to transfer!”, I encourage you to begin with a budget. Find any amount of money you can begin saving. Don’t be afraid to start small. Even if you are starting with $50 a month, that is something. As you become more disciplined and confident in your budgeting skills you will find money to add to that $50.
When to use it
While some things may feel like an emergency, be thoughtful and selective. Ask yourself these 3 questions before using your emergency fund:
1. Is this a need or a want?
2. Is this urgent?
3. Could this expense have been planned for?
If you answer these questions truthfully and you deem it appropriate to use your emergency fund, then use it. If not, reassess how you are planning for irregular expenses and other financial goals
Once your emergency fund is fully funded you will have the peace of mind knowing that when something unexpected comes up, you will be ok financially. The car trouble will still happen…you just won’t have the money trouble on top of it.
If you have questions or hit roadblocks along the way, I would be happy to help!