An emergency fund is money that you have saved up and set aside to cover any emergencies or financial surprises that life WILL throw at you. According to Money Magazine, 78% of Americans will have a major negative financial event in any given 10-year period. Some of the top emergencies people face are: Job loss, dental or medical emergencies, car troubles, unexpected home repairs, and unplanned travel. These unexpected events can be stressful and costly. Wouldn’t it feel fantastic to have a stash of cash somewhere that will cover these events?
Building up your emergency fund is extremely important because it’s essential to keeping you from going back in debt. You’ve worked too hard not to build up your emergency fund.
Step 3: How Much Should Be in Your Emergency Fund?
Every household’s financial situation is different. Some people say that if your situation is stable you’ll only need a 3 month emergency fund and others say you should have full years’ worth of expenses saved. I pretty much stand right in the middle. 6 months gives you a long time to be able to find a job, if you find yourself without one; it is plenty of money to fix a car repair or unexpected home repair; and it’s more than enough to pay for dental and medical expenses (if you have the proper health insurance). Having your 6 month emergency fund will give you peace of mind and a sense of security.
Now, take a look at your budget and look at what your expenses are every month (not your income but the money that actually gets spent). Multiply that number by 6 and that’s the number you need to hit to have a fully funded emergency fund. For the majority of households, $20,000-$30,000 will be what you want in savings but for some it will be more and others it’ll be less. Keep in mind, now that you’re out of debt, you will be able to save your 6 month emergency fund fairly fast and once you hit that number you’ll never have to go back in debt again!
Where Should I Keep My Emergency Fund?
Your emergency fund needs to be kept in a place that is easily accessible so you can get to it quickly. You should keep it in a savings account or money market account. I recommend a money market account because it pays a higher interest rate than your typical savings account (not that either are good). A money market account will give you around a 1% rate of return but a savings account won’t even give you that.
I know getting a 1% rate of return on $30,000 sounds like a terribly dumb thing to voluntarily sign up for but you don’t need to take the chance of losing any of your emergency fund to poor performance in the market. Your emergency fund is not there to be invested, it’s there to be used as if it were insurance.
What’s An Emergency?
The next time you find yourself facing an unexpected expense after your emergency fund is in place ask yourself a series of questions before freaking out and pulling money out of it: Did you expect this to happen? Does it need to be fixed right away? Is fixing it necessary? If you answered yes to these questions, you are probably justified in using money out of your emergency fund. However, I want you to ask one more question: Can I adjust my budget so that this problem is cash flowed by this month’s income? If this is also a yes, just leave the emergency fund in place and add the expense to your budget. You’ll be glad you don’t have to replenish the emergency fund in case another emergency pops up, but when one does, remember to ask yourself the questions above.
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