Budgeting & Saving
Why You Need an Emergency Fund
Emergencies happen whether we’re prepared for them or not and sometimes they can come with a large price tag. The best way to prepare for said emergencies is simple, build an emergency fund.
What is an emergency fund?
Firstly, let’s define what an emergency fund is before we start to build one. An emergency fund is essentially a savings account with a very specific role, to be there for you when a financial emergency pops up.
Secondly, what constitutes an emergency? An emergency can mean an unexpected event that would affect all or a part of your income. For example, if you were to be laid off or have your hours cut at work, this money would ease your anxiety about covering your mortgage or rent payment for the coming month. An emergency fund provides a buffer to prevent you from relying on credit cards and their high-interest rates to carry you through difficult financial times.
Of course, not all emergencies are as large as losing a job, an emergency fund could be used to cover a large home repair, a surprise car emergency, or an unexpected trip to the emergency room. So to make sure that these funds are there for you when you need them, open a separate savings account where you deposit money just for these types of situations.
An emergency fund is essentially a savings account with a very specific role, to be there for you when a financial emergency pops up.
How much money do I need in an emergency fund?
It’s generally accepted that an emergency fund should hold at least six months of your necessary expenses. This would include things like rent/mortgage, auto payment & insurance, food, and utilities. Think of the bills you would have to pay regardless of what’s going on in your life and add them all together.
For example, if your necessary monthly expenses add up to $4,000 you would need $24,000 saved in an emergency fund. This might seem like a big number, but don’t feel like you need to reach this amount by the end of the week. It is going to take time to save this much money, and that’s okay.
A great way to get started is to build saving into your budget. Add a line to your monthly budget labeled “emergency fund” and set up an automatic transfer into your savings account each month. Making saving an automatic habit will make building up your emergency fund something you don’t even think about. If you want to build your emergency fund up even faster save at least half of any big cash windfalls that you might receive throughout the year like a big tax refund or a bonus at work. It may take a few years to build it up, but when the inevitable happens (and it will happen), you’ll be prepared with money waiting for you.
Should I Invest in My Emergency Fund?So now that you’re building your emergency fund you might be wondering if you should simply leave it in a savings account with a low-interest rate or invest this money since historically the stock market provides returns near 10% compared to the low-interest rates offered by many savings accounts. Here’s the thing, if an emergency were to happen and you needed $2,000 quickly, you’d want those funds to be easily accessible and safe from the risk of the stock market. I’m a strong believer in investing, and I think we should all be investors, but investing does have its risks, especially in short time frames.
Yes, historically the stock market provides 10% returns, but that’s an average and not a guarantee. Furthermore, the market is known for constantly moving up and down. This volatility is why you should keep your emergency fund somewhere stable like a savings account where yes the returns will be much lower, but you can depend on the money being there and available when you need it.
So there you have it, building an emergency fund can be as simple as saving a small sum of money in a savings account every month. Making building an emergency fund a priority will help ease the burden of those unexpected and inevitable financial emergencies we all will experience.
BONUS TIP: Your emergency fund provides a buffer to help you get through life's unexpected events. When you ever need it, it is there for you, however, be sure to top it back off after you use it. That way it will contine to have your back for many year (and emergencies) to come.