As much as we may want to believe that we’re financial prepared to handle an emergency, the truth is that many Americans go into debt as a result of unexpected expenses each year. Looking at medical emergencies alone, even those who have health insurance coverage can go broke when dealing with hefty medical bills. Some people even go so far as to declare bankruptcy because they can’t afford to easily pay their bills and take care of additional costs that come with an emergency situation.
This is where an emergency fund can come in handy.
What is an emergency fund?
An emergency fund is a stock pile of easily accessible money that sits untouched until you absolutely need it. You might have hospital bills, need to purchase a new car or have yours repaired after an accident, have to fly to visit a relative who needs you, or any number of other unfortunate situations that are impossible to financially prepare for.
An emergency fund is intended to address those situations, and help you pay cash for them rather than going into debt. The key thing to remember is that an emergency fund is not for everyday savings goals – like purchasing a house, making a large purchase, or covering predictable bills. It’s supposed to give you coverage for emergencies only – otherwise, it needs to be left alone.
How much is in an emergency fund?
Typically, financial planners recommend that you have anywhere between 6 and 12 months of expenses in an emergency fund. This ensures that, even if you have to pay down a huge, unexpected bill – you’ll still be able to make regular payments on all of your other budgeted expenses. Having this big of a buffer in your emergency fund also insulates you against the sudden financial loss that comes with losing a job, or having to go on an extended leave due to illness or injury.
How do you start building an emergency fund?
If you already have a cash savings, that’s great! You’ve already gotten started on your emergency fund. However, it can be helpful to set aside some money in a separate savings account that’s accessible, but not necessarily your “go to” account for withdrawals. In some cases, it can also be beneficial to open a high-yield savings account as your “emergency fund” so that your money works harder at growing and adding to your nest egg. Remember – every little bit helps.
If you don’t have any cash savings on hand, that’s okay. As is the case with any financial goal, start small. Calculate your monthly living expenses, and set a goal to save up one month’s worth. Then, slowly add on month to month until you feel like you have a comfortable emergency fund built up.
Where does an “emergency fund” fall on my financial priorities list?
Honestly, an emergency fund should be one of your top financial priorities. Having it helps you achieve other financial goals – like staying out of debt, and being financially prepared. Again, if saving that much money feels overwhelming, start small. Having a few months’ worth of expenses on hand is enough to help you bridge the gap in case you’re facing a small-scale emergency. Until you have 1-3 months of expenses saved, you might consider hitting “pause” on a few of your other savings goals – like saving for a house down payment.
Remember: keep things accessible.
One key thing that many people forget is that an emergency fund must be accessible. Having cash tied up in a Roth IRA or other account that’s difficult to withdraw from is a mistake when you’re building an emergency fund. Of course, having these investment accounts is a great thing! Just not for this purpose. As tempting as it is to invest your emergency fund, if you need it in the event of a true emergency, being able to access your money quickly will be incredibly important.
If you do need to access your emergency funds, be sure to remember to replenish them as soon as possible. Keeping that savings account at a set balance should be a priority. Finally, as life changes, your “perfect” emergency fund balance should change, as well. Your monthly expenses are going to grow as you take on more financial responsibility, like having children and owning a home. Make sure your emergency fund appropriately reflects the amount of money you’ll actually need in case of an emergency.
If you need help creating a savings plan that prioritizes an emergency fund, I’d love to talk to you. Feel free to contact me today for a consultation.