Prepare for the Unexpected With an Emergency Fund
Emergencies are a part of life. There’s no way to predict them and often no way to avoid them — but you can plan ahead for an emergency, at least financially. By setting aside money “just in case,” you may be ready to handle an unexpected situation, like a car needing repairs or medical bills for a sick kid, without throwing your finances a curveball, too. Here’s what you need to know about having an emergency fund and when you may need to use it.
What Is an Emergency Fund?
Simply put, it’s money you save for unexpected expenses. You can add to the fund regularly but should only make a withdrawal for an emergency, like covering the cost of repairs for a broken washing machine or to pay bills after an unexpected job loss.
How Much Should I Save?
Generally, you should keep at least three to six months of expenses in your fund, says The Balance. You should also consider your circumstances. If you are a one income household, have children or have a family member with medical needs, it may be a good idea to have six months or more worth of expenses saved up, says DaveRamsey.com. However, if you’re part of a two-income household, or you’ve had a steady job for several years, then a three-month emergency fund may be enough.
If you are in debt, DaveRamsey.com recommends starting with a goal of $1,000 for your emergency fund. From there, you can start working towards saving the recommended three to six months’ worth of expenses.
Why Not Just Rely on Credit Cards?
Credit cards can be helpful in an emergency. However, if you cannot pay off the balance in full right away, you’ll typically end up paying interest on top of whatever you charged in the first place. So, you won’t just be paying for the cost of an unexpected expense — you may be paying interest to the credit card company, too. If you have an emergency fund available, you can use that to pay off the expense immediately and avoid incurring additional debt.
Where Should I Keep The Money?
You should ensure you can access the money in your emergency fund quickly, easily and without any fees or penalties, says the Financial Industry Regulatory Authority (FINRA). One option is to have a savings account at a bank or credit union, as withdrawals can typically be done quickly and your account will likely earn interest. Similarly, The Balance says a money market account may be another good option, as these accounts have similar features to savings and checking accounts and typically pay interest. If you’re looking to earn a little more interest, FINRA states that you could also consider a certificate of deposit, or CD, but keep in mind that you may lose the interest the CD earns if you have to withdraw the money early.
What If I’m Barely Making Ends Meet?
It’s OK to start slowly — the key is to start saving. Keep in mind that if you’re already in debt or are living paycheck to paycheck, even a small emergency can really set you back. It’s important to set a starting goal for your emergency fund and work towards it.
Chances are there is at least a small amount that you could use to start your emergency fund. Personal finance author Stefanie O’Connell recommends tracking your spending for a month and then looking for areas where you can cut back. For example, maybe you can lower your grocery expenses, or reduce your cellphone’s data plan to save money each month. Making small changes in your spending can help you build your emergency fund.
What Is Considered an Emergency?
A true emergency is one you couldn’t have seen coming. For example, you get sick and end up with a few unexpected medical bills. Or, your 4-year-old furnace goes out, when you should have had years before you needed to replace it.
Before you take money out of your emergency fund, DaveRamsey.com recommends asking yourself three questions about the situation:
- Is it unexpected?
- Is it necessary?
- Is it urgent?
If you cannot answer yes to these questions, it may not really be an emergency expense. However, this is something every individual has to determine on his or her own. When drafting your budget and your emergency savings, consider your absolute necessities — the things you can’t live without. That may be a good starting point in deciding what qualifies as an emergency.
What If I Have to Take Money Out of the Fund?
It happens, and that is why you have the fund — so you are prepared in case the car breaks down or the baby gets sick. It may be frustrating to see your savings reduced, but this is what the emergency funds were for. DaveRamsey.com says you just need to replenish the money as soon as you are able to, so that you’re prepared in case another emergency arises.
You may not be able to prevent an emergency from happening, but by setting up an emergency fund you may be financially prepared to handle an unexpected situation.
Originally published on August 14, 2011.