24 Jan The Importance of an Emergency Fund
Emergencies tend to happen at the most inconvenient and unexpected moments. You lose your job, your car breaks down, the water heater breaks, and other situations like these arise at the most annoying moments. We know that an emergency fund sound dull, but they are super easy and straightforward. All you have to do is set it up, then you can forget about it.
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Why Have an Emergency Fund?
When an emergency hits, you will likely freak out. You could be stressed, scared, sick, tired, or any other plethora of unpleasant emotions. The last thing that you’re going to want to worry about is money.
You don't want to suddenly have to max out your credit cards, take on a loan, sell investments that are performing well, or call family and friends begging for cash. An emergency fund acts as an insurance policy, making it easy for you to quickly access your money to pay for the emergency as needed. Accordingly, it's best to prioritize saving up your emergency fund before putting your money into investments.
How Much Goes into an Emergency Fund?
Before you save for anything else, you want to get a solid emergency fund built up. Generally speaking, you want to have 3-6 months’ worth of expenses set aside. Here are two quick examples:
- If your monthly expenses are $2,000 a month, then you want to have $6,000 to $12,000 set aside. ($2,000 x 3 to 6 months = $6,000-$12,000)
- If your monthly expenses are $5,500 a month, then you want to have $16,500 to $33,000 set aside. ($5,500 x 3 to 6 months = $16,500-33,000)
How Much to Keep on Hand?
Contrary to what grandma told you, you don’t want to keep your emergency fund in your mattress. That wouldn’t work out so well if your emergency turned out to be a house fire. While keeping some cash on hand is always a good idea, you don’t want to keep the whole fund at home.
The basis for cash on hand is $1,000; this will be enough to buy you and your family about three days of motel rooms, gas, and food. If you have a large family or unusual routine expenses (like specific medical needs), you may need to stockpile a bit more. However, for the average person, this will be enough.
Where to Keep Your Emergency Fund?
What to do with the rest? This money needs to be flexible. This means that you can quickly get it whenever you want and that it is not tied up in other investments; this is also known as “liquid” money. The best place to put this would be a high-interest savings account. Talk to banks in your area about their savings account interest rates and aim for a 1.7% or higher rate return on your money. You can also choose an online bank, like Ally Bank (not affiliated), if you are looking for a high return rate.
After you have safely stockpiled your emergency fund, leave it be. Keep it separate from your other accounts and don’t use it to fund vacations or special events. Let it sit there, accumulating interest until you need it. When an emergency finally hits, you will have easy access to enough money to get you through the crisis.
Now that you have built up your emergency fund, it is time to start saving for investments! We built an article explaining the Many Types of Investing Methods to give you a solid overview of where to start.
Are you trying to figure out what your monthly expenses are? Check out our article on How to Calculate Your Monthly Expenses.