What Is An Emergency Fund?
THE LOGIC OF MONEY
OCTOBER 17, 2019
Building an emergency fund may seem like an impossible task. We get it: You have kids, medical expenses, student loans, car payments, a mortgage, blah blah blah.
But you need to be prepared for an unexpected large expense (expect the unexpected). Crazy things happen all the time in our lives. Without an emergency fund, you will find yourself in a world of hurt.
You might be asking what is an emergency fund? It’s simply a chunk of money you set aside just in case something unexpected happens, such as your car blows a tire, your hot-water heater stops working, or you need to pay for an unexpected medical procedure (just went through this one myself).
Below, we are going to talk about these topics in-depth and help you start building an emergency fund for yourself.
Emergency Funds 101
An emergency fund is money that you set aside so that you are financially stable in the event of something financially surprising happens to you. This doesn’t just necessarily mean a surprisingly large expense. It could also mean that you or your spouse unexpectedly lose your job. Suddenly your income is cut in half, or completely wiped out. Will you still be able to pay rent, utilities, food, etc.?
I recently just had a medical procedure that did not go as planned. I ended up in the ER three different times post-surgery, had multiple emergency surgeries, and spent a few nights in the hospital. Luckily, my medical insurance covered the majority of the expenses, however, it ended up costing me 4x as much as I had initially expected. Without an emergency fund, I would have been struggling to pull together the money to pay for all my bills.
It is especially important if you have a family. What would happen if you lost your job tomorrow? Would you still have the money to pay for the roof over you and your kid's heads? Would you still be able to find the money to feed them for several months if you couldn’t immediately find a new job? This is why emergency funds are so important. It is essential that you have some money built up and put aside for unexpected events like this.
Building An Emergency Fund: How Much?
Your first goal should be to put aside $1,000 if you don’t have any sort of emergency fund started right now. Once you hit $1,000, then go for 1-months expenses, then 2-month’s expenses. Ultimately, you should aim to save 3-6 months of ALL living expenses. You should be able to cover your mortgage/rent, food, car payments, insurance, utilities, and any other expenses you may have on a month-to-month basis. Some may argue that you only need to cover the absolute necessities, however, I believe you should try to build up enough money so that you can continue to live the exact same lifestyle you had been living prior to the big expense or income loss.
You want to be able to enjoy the things you previously enjoyed and you want your kids to be able to live the same life they were living. You don’t want everyone to have to go into panic mode.
Once you get to 3-6 months of all living expenses, you should be pretty comfortable with your emergency fund. But, you have to be disciplined. Now that you have this big chunk of money saved up, it doesn’t mean you should use it to go buy useless things, it doesn’t even mean you should use it for a down payment. The only thing it should be used for is exactly what its name implies… EMERGENCIES.
You may consider putting it into a high-yield savings account so that while it’s sitting there it continues to grow. It never hurts to have an even bigger emergency fund. You may also continue to put money into your emergency fund after you have your 3-6 months saved up. This will give you even more peace of mind.
How To Build An Emergency Fund
1. Track Everything
Begin by making a list of your monthly income as well as your monthly expenses. Use a piece of paper or make a spreadsheet to track and figure out what your monthly expenses are. Track everything. Doesn’t matter if it’s as big as your monthly mortgage/rent, or as little as your $3 morning coffee. It is crucial to know how much money you are bringing in and how much money is going out.
2. Set Your Goal
Start with $1000 if you don’t have any kind of emergency fund already started. This may seem huge, but you absolutely can do it if you are monitoring how much money you are bringing in versus sending out. Then, you can aim higher and higher until you hit the recommended 3-6 months.
3. Make A Plan
Will you pick up a few extra hours at work? Will you look for a second job or do work for friends and family to earn some extra money? Will you cut out some of your other expenses to make room for some savings?
Break your big goal into smaller ones. Instead of getting a morning coffee from Starbucks and eating out for lunch every day during the week (these were, unfortunately, my extremely "healthy" habits for a while), get a coffee 2-3 times a week and pack lunch a couple of days a week. Before you know it, you will have saved hundreds of dollars.
If you haven’t ever read The Compound Effect by Darren Hardy, you ABSOLUTELY need to. The entire book illustrates how making little changes in your life like this can make HUGE differences in the long run.
4. Put the money out of sight
Put the money in a place you can easily access it but not too easily. Don’t just leave the money sitting in your savings account that you use to pay all of your other bills. Make a new savings account, at the same bank or at another bank (preferably a high-yield savings account or CD), title it “Emergency Fund”, and put the money in there. This way, every time you see it, you remind yourself that it is only for emergencies. You will be less likely to use it for other useless things.
5. Stick to the plan
This is the hardest part of it. You are going to be sick of picking up extra hours or doing odd jobs. You are going to want to cave and go to lunch with everybody. You are going to see that large sum of money just burning a hole in your bank account but, it is important to realize that when, not if, the time comes that you need to dip into your emergency fund, it will be there waiting for you. Having that security in your life will make you much happier and much less stressed out than the little bit of extra effort it takes to build your emergency fund
In the end, the most motivating thing is to keep in mind the reason you are building an emergency fund. It is to keep yourself and your family financially safe. To sacrifice and put in the extra work is difficult now, however, when the REALLY hard times hit, it will not be nearly as much of a burden on you or your loved ones.