If 2020 hasn’t convinced most people how important an emergency fund is, then there might not be anything that will! But how much for an emergency fund should you plan on saving for? Let’s find out!
What is an emergency fund?
An emergency fund is a readily available amount of money to pay for life’s urgent and unexpected expenses. When these unexpected but necessary expenses hit, you need quick available money to help cover the costs.
Why is it important to have one?
Emergency funds are important because your necessary monthly expenses don’t stop just because you are in a financial snag. These accounts are needed to help get through the unexpected events that would normally throw monthly budgets off track.
In the real world rent keeps coming, health and car insurance payments don’t stop, and groceries cannot simply be “put off” until next month. Having the proper amount of liquid savings places you in a position where you hopefully don’t have to choose between the two.
What are emergency funds for?
These funds aren’t just for ordinary unexpected events. Emergency funds should only go towards necessary and urgent expenses!
Losing your sunglasses and needing a new pair before your trip doesn’t justify dipping into your emergency fund!
Emergency funds should go toward real emergencies, well duh! Examples might include medical payments, unexpected car troubles, appliance failures, vet bills, etc.
All of these expenses are unexpected, but completely necessary in order for you and your family to continue living and working!
Emergency fund how much?
Almost everywhere you read about emergency funds, the standard amount is 3 to 6 month of savings.
Well what do they mean by that? You should be able to pay for 3 to 6 months worth of normal expenses without running out of money.
How do you know exactly how much your normal monthly expenses are?
3 or 6 month emergency fund?
Obviously a 6 month emergency fund is going to give you more protection than 3 months, but is it necessary?
Well, that depends. A few things that need to be considered:
- How stable is your job?
- How many incomes does your household have?
- Any dependents with chronic illness or frequent medical expenses?
- Is your career skillset easy to find another job if needed?
- Do you have high interest debt?
If you and your spouse both have reliable jobs with steady incomes, then a 3 month emergency fund may be sufficient.
However, if one of your dependents is unfortunately always needing medical attention, a larger emergency fund is probably more necessary.
Pay off debt or an emergency fund?
Another thing to consider is high interest debt. Credit card debt and other high interest loans may be putting you in a hole that is hard to dig out of. If you find yourself in this situation then you need a plan of attack!
Plan for paying off debt or an emergency fund:
- Continue to pay your minimum monthly debts.
- At the same time, save up to a mini-emergency fund of $1,000.
- Once $1,000 is fully-funded, attack high interest debt with all extra money
- Once high interest debts are paid off, work towards your 3 to 6 month of savings
Where should I keep my emergency fund?
Emergency funds are only useful if you can access the money easily! This should go without saying but it must be in an extremely liquid holding location.
A high interest savings account or money market is the best spot to park your money. These locations give you almost instant access to your money and also have debit/check writing abilities.
CDs, stocks, bonds, and retirement accounts should all have some allocation of your financial portfolio. However, your emergency fund should not be stored in any of these.
Why? Those accounts can fluctuate immensely sometimes losing money, some take 3-6 days to receive funds, and others will charge you early withdrawal fees.
Keep your money simple and accessible in checking or savings account that offers higher interest. Money markets are ideal.
How to save for an emergency fund?
Your first goal should be to achieve your mini-emergency fund. Try saving $1,000 before you start attacking your debts in full force.
Ways to Save for an emergency fund:
- Set up automatic contributions from your paycheck into a savings account
- Sell items on FB marketplace, craigslist, Letgo, ebay, etc.
- Turn a hobby into a small money maker such as a jewelry shop on Etsy.
- Easy to start side hustle: Dog walking, yard work, donate plasma, grocery delivery.
- Add a temporary work-shift to your schedule
- Trim “Wants” in your 50-30-20 Rule of Budgeting
How much to save is discretionary. It will be based on your job, family, and necessary monthly expenses. The emergency fund rule of thumb still resides at the three to six month amount.
Do not wait until your first emergency to realize you cannot pay the bills. Once you save up to your goal don’t stop there. Contribute to your tax-advantaged retirement accounts and start building your net-worth!