Emergency Fund Basics – Are You Ready For A Crisis?
Life happens. Emergencies happen. Are you ready to take on any financial crisis that heads your way? Having a well-funded emergency fund will help you weather the storm. But when you have bills to pay, how can you even begin to imagine building up some cash? Today we’ll explore the ins and outs of emergency fund basics.
Why An Emergency Fund In The First Place?
It’s simple. Unexpected events happen while you’re budgeting, and they can’t always be paid for using your monthly income. Cars break down. Trees fall through homes. Medical issues arise. You get the idea! To live debt free, you’ll need to pile up some cash to ensure you don’t go back into debt.
Here’s an idea: Ask friends and family members what kind of emergencies they’ve had in life. No doubt, they’ll be able to tell you a few stories where they paid more than expected. You’ll quickly see that emergency funds are not only nice to have, but necessary!
The First Steps
It was mentioned that emergency funds can be difficult to build when you have most of your income already going to expenses. There are some preliminary steps to undertake when this is the case. Here they are below:
- Build a small emergency fund. Dave Ramsey recommends $1,000. This will get you started and allow you to handle the little things that life throws your way.
- Eliminate your non-mortgage debt. This frees up your cash flow so that you can put more money towards your emergency fund.
- Make sure you’ve lowered expenses and raised your income. This will further allow you to pile up the cash! Make sure you find the lowest price on goods and services. Discover new ways to bring in some extra cash!
After you’ve completed these first steps, you’re ready to begin figuring out your emergency fund strategy!
How Much Should I Save?
There are two parts to this question: the rate at which you should save and how much in total you should save. Both answers depend on your situation, but let’s start with some generalizations.
The rate at which you should save is dependent on how quickly you want to reach your goal. Everyone has a different comfort level. If you generally don’t have much risk (ex: no pending emergencies, or not many assets to protect), you might divert some of your leftover budgeting money to other important goals. Most, however, need to get serious about putting their fully-funded emergency fund in place.
That leads us to the next question: how much money should you save? I recommend 3 to 6 months of expenses. Ask yourself, “If I were to lose my job, how much money could I live on for 3 to 6 months?” The answer to that question should be how much you need to save into your money market or savings account.
By default, you should choose 6 months worth of expenses. But if you estimate that your situation only requires 3 months of expenses, go for it and invest the rest! People who choose 3 months of expenses usually have high-paying jobs, are single, have been in their current job for many years, and/or see little opportunity for emergencies to arise.
When Can I Tap That Emergency Fund?
It’s simple to label a savings account “emergency fund” and forget about it. But then, all of the sudden an urge from deep within can prompt you to tap your emergency fund in the name of getting that brand new car you so desperately need. That’s why it’s crucial to clearly define what an emergency fund is and when it can be used.
At our house, my wife and I put the expense in question through a litmus test. We have the following emergency fund guidelines:
The emergency fund can be used when an expense is both:
- Non-discreationary. If no action is taken it will endanger: necessary food, utilities, housing, reasonable transportation, or health.
- Unexpected. It must be something that couldn’t have been foreseen or budgeted for monthly.
This test has allowed us to objectively evaluate every time we wanted to use the emergency fund – thus saving us a lot of money.
Those are the basics. I can assure you that once you’ve reached your emergency fund goals, you’ll feel relief knowing that you’re safe from financial disaster. Do you have an emergency fund already? What’s your story?
