Emergency Funds: Your Financial Safety Net
Raise your hand if you have an emergency fund. Okay, to be fair, I can’t see if you raised your hand, but I know a bunch of you reading this didn’t – and not just because you knew I wouldn’t see. Having an emergency fund is a really important part of a solid financial picture.
Most experts suggest you have a minimum of 3 months worth of expenses in your emergency fund. Some even recommend you have as much as 9 months saved up. The rationale is that if something unexpected happens, like the loss of a job, it gives you a cushion to live on before you start having trouble paying your rent or mortgage, or have to start pulling money out of your 401(k) or ask your family for help.
I know what you are thinking, saving 3 months worth of expenses sounds daunting, if not impossible, right? Let’s not even talk about 9 months. But you can do it, I promise! First, expenses do not equal income. This means your emergency fund doesn’t need to replace your income, it just needs to cover your rent/mortgage, utilities, car payment, school loan, groceries, whatever necessary monthly expenses you have. It doesn’t include money you earmark each month toward savings, and it also doesn’t include any optional expenses you incur each month. So if your budget has a line item for travel, cut it from your emergency fund calculation. Your line item for expensive clothes, cut it. In an emergency, all the luxuries get put on hold.
Now that we’ve trimmed down the emergency fund goal to a more manageable number, let’s talk about how we start building it. You want to build this just the same way you would build your savings accounts. Open a separate bank account and decide on an amount of money you can contribute each month. If you have the option, set it up through your employer so that the money goes automatically each month into your account. If you are starting from zero, you might want to contribute more to your emergency fund account at first, or pause contributing to your savings until you’ve accumulated a good chunk into your emergency fund. After all, your emergency fund is really just a savings account in disguise.
The real difference between an emergency fund and other kinds of savings is the liquidity. If you are consistently saving money each month, you might be investing it or otherwise locking it up so in an emergency, you’d have to compromise the investment in order to use it. An emergency fund should be easily accessible for said emergency. This could be a savings account, or a breakable CD, but ideally something flexible where you are gaining at least some interest.
You might be asking yourself why we would recommend keeping money set aside earning a low interest rate and not instead using it to pay off those higher interest loans. Well, it’s all about that safety net. Knock on wood, you never unexpectedly find yourself out of work, but if you did, you want to be in a position to support yourself until you find a new job. Without an emergency fund, you might have to pull money from investments, or worse, fail to pay those loans at all and incur late fees and even more interest, or start putting all of your expenses on a credit card, charging even higher interest. You get the idea. Having an emergency fund is important!