Everyone needs an emergency fund. Life is going to happen, and those unexpected expenses can sometimes come with some serious sticker shock.The emergency fund provides that buffer between you and life, and prevents you from incurring debt when a true emergency arises.
When life throws you a financial curve ball, the emergency fund will turn what would otherwise be a crisis that has you running for your credit card, into an inconvenience that has you writing a check. Let’s look at the four steps you can take to help you start to build your fully funded emergency fund.
1. Open an account that’s accessible, but not too accessible:
When an emergency occurs you want to make sure that you can easily access the funds, but not have them so accessible that you accidentally spend the money on items that are not emergencies. Consider opening up a separate savings account that is not attached to your debit card. We have ours in a higher interest rate savings account where the money can be transferred into our checking account within 24 hours.
Remember though, your emergency fund is insurance rather than an investment. We’re not looking to make big returns on the money that is sitting in this account. If you make some interest (I think we earn $5 a month), that’s fine, but earning money is not the intention. The intention of this money is to protect the rest of your finances – including any investments.
2. Determine what 3 to 6 months of living expenses are:
Most financial experts agree that a fully funded emergency fund should contain 3 to 6 months of living expenses. In order to determine this amount, go back to your budget and look at the essential expenses that you would need to cover in order to get through each month. Add up your housing costs, transportation costs, monthly grocery budget, and any other monthly fixed expenses that you would still be obligated to make (insurance premiums, etc).
In order to determine whether you should be closer to the three or six month savings mark, you also have to factor your risks. If your job is stable and you are in good health or if you have disability coverage through work if you were to become ill, you could consider keeping your savings closer to the three month mark. If you are self-employed or have a variable income, you would want to set your savings goal closer to the 6 month mark.
3. Set aside a savings goal in your monthly budget:
When you add up the amount to save, it might seem overwhelming at first, but don’t let that stop you from working towards this goal. Start small with a starter emergency fund and once you get all of your debts paid off (minus your mortgage), then you can focus on building that emergency fund by taking what you were putting towards debt and now putting it into savings.
Each month when you make your budget, look at the money you have left over and commit a certain amount of it to your emergency fund until it is fully funded. The more you are able to set aside for your emergency fund, the faster you will hit your goal amount.
4. Only use the money for emergencies:
The best way to make sure that you are building your emergency fund is to only use the money in that account for actual emergencies. So what constitutes an emergency? Any major expense that you couldn’t have anticipated, such as:
- An unexpected job loss
- A medical emergency
- A sudden, major car repair
- A leaking roof during a storm
What doesn’t count as an emergency are those expenses that we should have anticipated and been planning for already. Christmas, annual insurance premiums, and regular car maintenance are not emergencies so be sure to plan for these somewhere else in your budget.
Our emergency fund has saved us in a couple of occasions over the last three years and turned those “emergencies” into much less stressful inconveniences. When it was not only raining outside during a particularly heavy storm, but also raining inside, we had the money to be able to put on a new roof. More recently when our minivan, and main form of transportation, decided to pack it in, we were able to use some of the funds from our emergency fund to purchase a new to us car with cash.
If you’re lucky, you’ll be able to leave your emergency fund sitting untouched, but if the time arises, you’ll be glad that it is there.
- What has life thrown your way that either made you glad you had, or wished you had, the extra funds available?