Emergencies happen! When one does occur it can affect your finances drastically! We will discuss some guidelines I used on establishing a proper emergency fund for my family.
What is an Emergency Fund?
Let’s start with the definition of Emergency fund.
Investopedia defines it as – The term “emergency fund” refers to money stashed away that people can use in times of financial distress. The purpose of an emergency fund is to improve financial security by creating a safety net that can be used to meet unanticipated expenses, such as an illness or major home repairs
How much should my Emergency Fund be?
Three to six months of expenses is what you hear most of the time. Here are some of the things I took into consideration when establishing mine.
1) How stable is your job? By this I mean is there a high turnover rate at your job? Do you see yourself leaving your job anytime soon?
2) How quickly can you find a new job if you lost your job? You need to take in consideration how quickly you can find gainful employment if for some reason you lost your job. If you have a job in music therapy for animals and you lost it. Well to be honest it would be very difficult to find a new job. However if your a salesman you probably can find a job rather quickly
3) Who are you responsible for? If it’s just yourself. You can more than likely get away with three months in that case. However if you have a family you’re responsible for, then six months may be better suited for you.
4) Are you the only income in your household or are there multiple incomes? By this I mean both you and your partner work and contribute to your monthly expenses. If you lose your job and your partner continues to work your emergency fund will last longer.
These are the questions i asked. When deciding to establish a six month emergency fund for my family.
Can I Fund more than Six Months?
There is no problem with going over six months. Having enough funds available for emergencies is the key. Some people like to have a year’s salary. That is all dependent on you and your situation.
I personally keep mine at six months expenses so I can invest anything over. I would say there is a point where you have too much in your emergency fund. However it’s better to have too much than nothing in your emergency fund.
When should I start my Emergency Fund?
When I started my journey to reach financial freedom I had no emergency fund. When my wife and I decided to start our emergency fund we decided to establish one month’s expenses. Then pay off our bad debt and then fully fund our emergency fund. The reason we did this was to give us some breathing room. We had never followed a budget and wanted a safety net.
Dave Ramsey likes to say save $1000 dollars then pay off debt. Then establish a fully funded emergency fund. Not too different from what my wife and I did.
Personally I would never fully fund an emergency fund before paying off bad debt and incurring more interest.
Expenses not Income!
It’s important to understand what expenses are. Your monthly expenses are the amount required to make all required monthly payments and living costs. Living costs are food, gasoline, and any other things required to live. Many people misunderstand this and think that they need to save their income for each month. If your income is $3,000 monthly and your required expenses are $2,000 then all you need is $6,000 to $12,000 in an emergency fund. Instead of $9,000 to $18,000.
Where should I have my Emergency Fund?
I personally have my emergency fund in a High Yield Savings account. Which grants me a 4% return rate on average. This is not an investment account, this is a SAVINGS account.
High yield savings accounts are not the only place to park your emergency fund. Some people use their normal savings, some keep it in their house. No matter where it is, you want to ensure it has liquidity and you are not putting it at risk.
This account is meant to never be touched unless an emergency does occur.
When should I use my Emergency Fund?
It’s in the name. Emergencies!
An emergency is not buying a new car, getting that new toy you want, putting a down payment on your new home.
You lose your job. You have a major life event. The intent is if you have something happen that would financially set you back you use your emergency fund to supplement till you can recover. This keeps you from going into debt.
If you have reached the point of getting debt free wouldn’t it be nice not to go back into debt because of one bad event.
Remember when you use your emergency fund ensure you replenish it as fast as possible.
Conclusion
An emergency fund is a great layer of protection to have. The intent of it is to use it only for emergencies. Establishing how much you need to fund it will be based on your personal situation. Make sure the funds are liquid and easily accessible. An Emergency fund will give you a tremendous amount of peace. Establish a fully funded emergency fund as fast as possible. Because not having an emergency fund is an emergency.
