Your home or car was damaged in a storm. Your spouse lost his job. Insurance didn’t cover some of your medical bills. Life is full of unexpected twists and turns. That’s where an emergency fund comes in. It serves as a financial cushion allowing you to pay for unforeseen expenses without resorting to getting cash from more costly sources that could further jeopardize your financial security.
Why Do You Need an Emergency Fund?
When you’re already struggling to save money for various goals, putting aside extra money for emergencies may seem impossible. However, having an emergency fund is essential. It prevents you from using high-interest credit cards or loans, dipping into long-term savings or retirement accounts, or selling off investments in a bad market because you need the money in a crisis.
How Much Should You Save?
Typically, financial experts recommend setting aside three to six months’ worth of living expenses. However, you should consider your circumstances, including your job stability, income consistency, health (yours and family members), debts, whether you are the sole breadwinner, and other factors. If you’re retired, six to nine months is better because you no longer have income from a job, you are more likely to face unexpected health costs, and your money may be tied up in investments that would be costly to liquidate on short notice.
What Steps Should You Take to Build Your Emergency Fund?
The first step is to determine the total amount you need. Calculate your monthly income and expenses and multiply it by the number of months you’re saving for, adjusting the time period for any special circumstances you may have.
If you don’t have enoughcash to put into an emergency fund immediately, you’ll need to start saving for that goal. A budget can help you do this. It’s where you lay out your monthly finances and determine what adjustments you must make to your spending to save for different goals.
To accelerate building your emergency fund, you should cut nonessential expenses and direct that money to your emergency fund. You may also want to consider prioritizing your emergency fund before other goals such as saving for a house or retirement. That doesn’t mean eliminating all your other savings goals, but you may want to shift more money toward the emergency fund in the short term.
Next, set up automatic transfers to a dedicated savings account for your emergency fund. Monitor your expenses carefully to help you stay on track.
Importantly, your emergency fund should only be used for emergencies like urgent repairs, job loss, unforeseen medical expenses, and the like. It isn’t another savings account that you can use to pay for your vacation or routine expenses.
If you do use emergency funds for any reason, you must remember to replenish them. That may mean going back to saving every month to ensure your funds will be there when you need them.
Where Should You Put Your Emergency Fund?
Your emergency fund should be in a separate account, so you don’t use the money for any other purpose. It should be accessible, meaning you can get cash out quickly. A high-yield savings account or money market account is best.
Relying on investment or retirement accounts as your emergency fund should be avoided. Selling off stocks or withdrawing funds from retirement accounts can have significant tax consequences, possible penalties for early withdrawals, and reduce the value of assets that you’ll need later in life to support you.
Building an emergency fund takes time and discipline, but you can start with small, consistent contributions. The effort will be well worth it if you should need that money in a crisis.
If you need help creating a budget to improve your finances, contact me for a free consultation. I work with clients to teach them how to manage their day-to-day finances or I can handle any tasks they prefer to delegate. Either way, my goal is to help them feel more in control over their finances.
