One important piece of a solid financial foundation is the Emergency Fund. Keeping an emergency fund allows you to have cash on hand for unexpected expenses. No one knows when their washer and drier is going to go out, or a car accident happens, or a spouse loses a job. Your emergency fund is the insurance policy that protects you against these risks.
When we think of needing emergency cash, we tend to think of appliances breaking in our home, a large medical bill, or repairing a wrecked car. Those expenses might be covered by keeping an extra thousand or two in the bank, but what about losing your job?
Earlier this year, my wife Tracy and I learned firsthand the importance of having a full emergency fund. After we were married, we decided to put the amount we were saving towards our wedding into an emergency fund. Our goal was to get at least 3 months worth of necessary spending in a savings account.
Four months after we started, Tracy finds out she will be laid-off in two months. We were shocked and in disbelief. Although this was a huge blow, we knew we were on track to have a 3 month emergency fund in place by Tracy’s last day.
I can’t imagine how much more stressful this situation could have been if we were not adequately prepared for this type of an emergency. Not only did our emergency fund give us peace of mind, it also allowed Tracy more time to look for a job or pursue a new career path without worrying about money.
What It’s NOT
Hopefully our story makes you think a bit more about a plan for your emergency fund. Before I give you some pointers on how to find out how much you need save, let’s cover what an emergency fund is not.
An emergency fund is not for car or home maintenance, your auto registration, or Christmas. Each month you should set aside some money specifically for these types of items. If you want to spend $500 on Christmas gifts each year, put away $42 a month into an envelope, and come Black Friday, you’ll be prepared.
An emergency fund is not money tied up in stocks or CDs. Your emergency fund money should be kept in a location you can easily get to within a day, if needed. The emergency fund doesn’t necessarily need to be in physical cash, although keeping some cash stashed away might be useful in case you can’t get to a bank or ATM.
Make it a little difficult for yourself to use that money. You don’t want to mingle it in with your regular spending money because it could be too tempting to use for non-emergencies. We keep our emergency fund in a savings account at Ally. It’s not our normal bank, so we aren’t tempted to spend it, but we have quick access if needed. Ally also has a 1% interest rate on their savings account, so we get a nice little bonus each month too!
The Magic Number
OK, so how much do you need in your emergency fund? Answer, it depends. The recommended amount is generally 3-6 months worth of necessary (aka non-discretionary) spending.
Start by writing down each bill you have to pay each month. Think rent, mortgage, insurance, utilities, student loans, car payments, credit cards, etc. Don’t include things like your gym membership, Spotify subscription, or money you spend on going out. Keep the job loss scenario in your mind. If you lose your income, you only want to be spending money on critical items.
Add in money you would spend on other life necessities like food and fuel. It might not be a bad idea to add in a little amount of child care expenses as well. You might find child care to be very beneficial if you need to go to job fairs or interviews.
Once you have the bare minimum amount you have to spend each month, simply multiply that by the number of months you want to save for and bingo, you’ve got your emergency fund target.
If you are married and only one spouse normally works, you’ll want to have an amount closer to 6 months in savings. If both of you work, you could probably get away with only 3 months. The chances of you both losing your job would be slim, so the 3 months worth of savings will stretch a lot further when you still have one income.
Now that you have your emergency fund goal in mind, start chipping away at your goal each month. Make a payment to yourself and think of it as an insurance premium, except it goes into your pocket! Find ways of cutting some of your unnecessary expenses that you can re-direct into savings. If you don’t already have a budget, now would be a great time to start.
Picking up a part time job temporarily or holding a garage sale are another few ways of building up some extra savings. Since I work from my home office, Tracy and I decided we didn’t really need two cars anymore. We decided to sell hers and put the proceeds into our emergency fund to give us a full 6 months.
Have you been in a situation where your emergency fund saved your butt? Share your story in the comments!