Building an emergency fund that you can tap into when life throws you curveballs can turn what would otherwise feel like a major blow into a fairly minor inconvenience.
We've all experienced an unexpected financial emergency at some point. Whether you’ve encountered an unforeseen loss of income, a surprise medical bill, or your furnace went on the fritz in the middle of the winter, unplanned expenses can make an unfortunate hit to your budget. Not to mention, they often seem to come at the worst times, when the money is already allocated elsewhere. This is why it’s so important to have an emergency fund.
The reality is, things happen. Much of what we claim to be unexpected is practically inevitable; we just can’t always predict when the time will come. It’s important to make it a priority to be prepared for anything by building a sufficient emergency savings fund.
What is an emergency fund?
An emergency fund is money set aside specifically to cover life’s unexpected events. It serves as a safety net to catch you when you suddenly need funds, fast. You never know what will happen or when, and you can’t always have enough to cover every emergency, but the idea is to cushion the blow and have cash on hand whenever you run into a bump in the road.
But keep in mind, the purpose of an emergency fund is for true emergencies, not “nice to haves” that merely feel like something you urgently need.
If your friends invite you on an impromptu couple’s weekend and you don’t have the cash, this isn’t the time to tap into your emergency fund. If that gadget you’ve been wanting is on sale and your checking account balance is running low, this is not an emergency. Just remember, your emergency fund is there to get you out of a bind when unavoidable expenses or loss of income sneaks up on you.
If you lose your job tomorrow, can you cover the mortgage until you find a new job? If your car breaks down, can you afford to replace the transmission this week? This is when an emergency fund comes in handy.
If the situation is unexpected, urgent, and unavoidable, then it probably qualifies as an emergency that justifies tapping into your fund. Otherwise, you should leave the money untouched.
How much cash should I build into an emergency fund?
If your household income is unpredictable, you may need to build a bigger emergency fund than someone with a stable income and a relatively secure job. If you have limited expenses and no children, you will need less than someone with a sizable budget and a house full of kids.
It also depends on your overall financial situation. If you are saddled with debt, your priority should be to pay down those balances, so your emergency fund may be smaller at first. But a good rule of thumb would be to have a bare minimum of $1,000 put aside for emergencies at all times.
Most households with a relatively stable income should aim to have at least three months’ worth of expenses saved. If your household relies on a single income, self-employed income, or straight commission, you’ll want to aim for at least six months’ worth of expenses in your emergency fund.
Where should I stash my emergency fund?
Many people prefer to put savings away somewhere they can’t access it easily, so they will be less likely to use it on a whim. Your emergency fund, however, needs to be somewhere you can access it quickly and easily—in case of emergency.
In other words, your emergency fund should always be liquid—cash that you can withdraw with a moment’s notice.
Ideally, you should put the money in a checking or interest-bearing account that enables you to use a debit card or write a check. If you think you might be tempted to use the money if it’s attached to accounts you often use, open an account at a separate bank and leave the checks and debit card at home.
How do I build an emergency fund?
If you don’t have any emergency savings, the first step should be to fund your first $1,000 as soon as you can. If you have investments in other accounts, this might be as simple as liquidating some assets to set the cash aside. If you don’t have the money, consider selling some items or doing some side work to come up with that amount quickly.
After you have the first $1,000 set aside, make a goal to build your fund as quickly as possible.
Make a budget: Start with getting clear on your household expenses, cutting unnecessary costs, and setting a realistic budget.
Set a monthly goal: Identify a specific amount to save each month and treat it like a bill, no different from your mortgage or rent.
Automate your savings: Set up an automatic deposit into your emergency fund account to make it easier and eliminate the temptation to skip a payment.
Add extra payments: If you come into extra money from a raise, selling items, or a part-time job, add it to your fund until you hit your target. Every little bit helps.
Building an emergency fund is like having an extra insurance policy in place. When life’s unwanted financial emergencies come up—and they always will—you can breathe a little easier with the confidence that you can cover the expense.
Now that you know the importance of emergency savings and how you can build your fund, what are you waiting for? It’s never too late to get started.
John J. Diak, CFP® is the Principal & Client Wealth Manager at Oatley & Diak, LLC in Parker, Colorado. He assists clients through many difficult lifestyle changes such as business downturns, retirement planning, divorce, the death of a spouse, and family estate issues among others. Oatley & Diak, LLC is a family-run registered investment advisory (RIA) firm that provides clients with investment management and financial planning services in a hands-on, intimate environment. Learn more about them at oatleydiak.com.
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual.
This material was prepared by Crystal Marketing Solutions, LLC, and does not necessarily represent the views of the presenting party, nor their affiliates. This information has been derived from sources believed to be accurate and is intended merely for educational purposes, not as advice.