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We have previously discussed saving your money for a down payment on your home. In the near future we will talk about what some call the envelope system of saving for particular expensive items. But the foundation for all of that is what I would call an emergency fund. Room to breath.
Life happens.
We all know that, and we know that life costs money. The expected expenses we will ease with the envelope system, but what about the unexpected expenses. Your kid gets sick. Somebody backs into your car.
You know approximately how long your refrigerator will last, but when will your check engine light come on?
Does stupid stuff get in the way of accomplishing financial goals?
Maybe you’re chugging right along making all the right moves to achieve your financial goals then… BAM! Something happens (A car accident? A root canal?) and you’ve got to come up with some cash to deal with it. This is when you need emergency savings to handle unexpected situations and expenses. Otherwise, a little problem can turn into a big problem, or, at least a big setback.
How much do I need in my emergency fund?
Start with a simple solution (that is sure to help you sleep better at night).
You can always start with this approach: add up the amount of all your insurance deductibles (medical, auto, and renters/homeowners) and set that as your base for your emergency savings account. Having the money to cover your deductibles means that, in the event of a serious emergency like a car accident or injury, you can cover the deductible without going to a loan company.
Being able to cover your deductibles is a great start. With this approach, you’ll be able to deal with the most common financial emergencies. Even if you just start with an emergency fund of just $300 to $500, it will help you feel more prepared and less panicked if an emergency hits.
Eventually, you will find it comforting to increase your fund to a month’s income amount and then two and three.
I doesn’t matter how much you start with, just remember two things.
Start saving in that fund NOW and don’t stop until you have the amount you want. Cal Newport said it best when he said “Start small and start immediately.”
Don’t spend ANY of it if there is no emergency.
Keep the money in a bank or credit union where it is accessible, but where it does require you to jump through a hoop or two to put your hands on it. Make it inconvenient to transfer to your cash or checking account.
Can I Party on My Emergency Fund?
Before you decide to use your emergency savings, consider this.
Is it really an emergency? A flat tire is an emergency. A broken arm is an emergency. Regularly occurring expenses like birthdays, holidays, and new school clothes are not. If you know when something is due, plan for it during the year.
Is it a want or a need? Wants are nice to have but not essential. Eating out or going to movies are not needs. Needs are the essentials, the basics of life that you must have to survive.
Do you need it right now? These funds need to be saved for broken appliances, emergency room visits or car repairs ONLY.
Remember that whenever you do decide to use your emergency fund, you can feel proud that you were able to avoid using your high-interest credit cards or borrowing money from friends and relatives. Feel good about using your emergency fund for its intended purpose!
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Then start saving it back up again!
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Without savings, a financial shock—even minor—could set you back, and if it turns into debt, it can potentially have a lasting impact. Research suggests that individuals who struggle to recover from a financial shock have less savings to help protect against a future emergency.
Emergency funds create a financial buffer that can keep you afloat in a time of need without having to rely on credit cards or high-interest loans. It can be especially important to have an emergency fund if you have debt, because it can help you avoid borrowing more.
Saving $5,000 in an emergency fund can be enough for some people, but it is unlikely sufficient for a family. The amount you need in your emergency fund depends on your unique financial situation.
An emergency fund is essentially money that's been set aside to cover life's unexpected events. The money will allow you to live for a few months should you happen to lose your job or pay for something unexpected that comes up without going into debt.
Nearly one in four (22%) of U.S. adults have no emergency savings at all, Bankrate found—the second-lowest percentage in 13 years of polling. That's especially bad news given that most Americans would need at least six months of emergency savings to feel comfortable day-to-day.
An emergency fund is a separate savings account designated specifically for emergencies or unexpected expenses. For example, you might dip into your emergency fund if your laptop malfunctions or is stolen, you need an additional textbook to succeed in a course, or you have urgent medical bills to cover.
While the size of your emergency fund will vary depending on your lifestyle, monthly costs, income, and dependents, the rule of thumb is to put away at least three to six months' worth of expenses.
Those include things like rent or mortgage payments, utilities, healthcare expenses, and food. If your monthly essentials come to $2,500 a month, and you're comfortable with a four-month emergency fund, then you should be set with a $10,000 savings account balance.
And one crucial detail to note: Millionaire status doesn't equal a sky-high salary. “Only 31% averaged $100,000 a year over the course of their career,” the study found, “and one-third never made six figures in any single working year of their career.”
Bankrate's latest survey results found 56% of U.S. adults lack the emergency funds to handle a $1,000 unexpected expense and one-third (35%) said they would have to borrow the money somehow to pay for it.
A $20,000 emergency fund might cover close to three months of bills, but you might come up a little short. On the other hand, let's imagine your personal spending on essentials amounts to half of that amount each month, or $3,500. In that case, you're in excellent shape with a $20,000 emergency fund.
It's important to have cash reserves available, but $100,000 may be overdoing it. It's important to have money available in your savings account to cover unforeseen expenses. Plus, you never know when you might lose your job or see your hours (and income) get cut, so having cash reserves at the ready is important.
Fewer than half of Americans, 44%, say they can afford to pay a $1,000 emergency expense from their savings, according to Bankrate's survey of more than 1,000 respondents conducted in December. That is up from 43% in 2023, yet level when compared to 2022.
How much should you save? While the size of your emergency fund will vary depending on your lifestyle, monthly costs, income, and dependents, the rule of thumb is to put away at least three to six months' worth of expenses.
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Maybe you’re chugging right along making all the right moves to achieve your financial goals then… BAM! Something happens (A car accident? A root canal?) and you’ve got to come up with some cash to deal with it. This is when you need emergency savings to handle unexpected situations and expenses. Otherwise, a little problem can turn into a big problem, or, at least a big setback.
