Financial experts often recommend putting money aside for a rainy day, but that's easier said than done. When you're trying to juggle all of your obligations, it can be hard to prepare for "what-if" expenses.
On the flip side, if you're making good money and are easily in the black every month, it may not make a whole lot of sense to set money aside for an emergency. Why, then, should you have an emergency fund? Allow me to explain.
Why is an Emergency Fund Important?
An emergency is, by definition, an unexpected event. It can be small, like your dog converting your garden hose into a sprinkler hose. Or, it could be big, like your furnace giving up the ghost in the middle of winter. Even on a tight budget, small things like a broken garden hose are usually manageable.
However, even the most well-funded budgets can take a hit from a major, unexpected expense. It only takes one engine failure, prolonged hospital stay, or lay-off to put someone in a very serious financial situation. An emergency fund can definitely help.
Let's say you have a decent job, and you live comfortably. Things are going well until your trusty car breaks down. The mechanic tells you that it'll cost over $2,000 to fix. You don't have enough in your savings account to cover it, and going without a car isn't an option. You now have a choice: either put the repairs on your credit card and pay it off with interest over several months or skip a student loan payment. Neither option is very attractive, and both can cause serious financial problems for you.
Now, suppose you still have a decent job, but you've got a nice, well-funded emergency fund. Instead of running up your credit card or taking a hit on your student loans, you pull the money out of your emergency fund, pay the mechanic, and move on with life. Problem solved, and the only damage done is to your emergency fund, which you can build back up again over the next few paychecks.
Building an Emergency Fund
The exact amount for a good emergency fund varies from person to person, but a good goal to shoot for is six months' worth of expenses. This includes rent/mortgage payments, groceries, utilities, and any other non-negotiable expenses for that time frame.
Saving up that much money can seem daunting but quite possible. Take a look at your current budget, and determine what you can cut back on. Instead of stopping for coffee on the way to work every day, dust off that trusty little coffeemaker that got you through all those finals in college, grab a travel mug, and make your own coffee. Assuming that you're spending $4 a day on coffee, that's $20 a week and about $80 a month in coffee money. If you put that $80 into your emergency fund every month for a year, that's $960, which can make a real difference in the event of an emergency.
Essentially, you'll want to shave a few dollars off here and there to put into your emergency fund. Do this religiously for every single paycheck, and before you know it, you'll have a well-stocked emergency fund and less stress in your life.
If you live in a state that has a very high cost of living, you may want to save even more. To determine how much you should save, use the Motley Fool's emergency fund calculator. And, if you're a big fan of apps, consider these time-saving apps for saving money seamlessly.
The Definition of Emergency Expenses
Once you have a rainy day fund, it's tempting to use it for expenses that aren't necessities. So, decide that you'll only use the funds for urgently needed medical care or major car repairs, for example. Most importantly, you'll want to set money aside in case you ever lose your job. In such an instance, a well-stocked emergency fund can tide you over until you find another employment opportunity.
How to Build an Emergency Fund
1. Write Down Your Necessary Expenses
First, you'll want to write down how much you spend on groceries, transportation, food/rent payments, etc. Only include essential expenses in this calculation. It's helpful to know how much you spend so you can know how much to save.
2. Write Down What's Left After Your Expenses
You'll want to write down what money is left over after your expenses. You'll know how much you can save after this. Make sure you set a goal that's easy to reach.
3. Put Some Cash Into Your Emergency Fund Every Month
After tracking your expenses, it's time to set aside a bit of money every month. This could be $5 or $500. Decide how much you can reasonably save from your paycheck and do it.
The Benefits of an Emergency Fund
It Gives you Peace of Mind
Having an emergency fund will help ease your worries. You'll know you're prepared for life's challenges. No matter who you are, there's nothing more reassuring than knowing you'll be able to support yourself for six months if push comes to shove.
You're Prepared for Unexpected Expenses
If you fall ill, you'll at least be able to pay for a good chunk of your medical care. And, if you're involved in a car accident, a rainy day fund will be useful. Whatever the emergency, your savings will help ease financial stress and worry.
You Won't Have to Dip Into Your Retirement Accounts
Having an emergency fund gives you a financial cushion so that you won't have to pull money out of your retirement account before you need to. You can feel more confident, especially when you have a little bit of money set aside.
You can Pursue Investment Opportunities
If a great investment opportunity comes along, you have the money to pursue it.
That said, having an emergency fund allows you to prepare for the setbacks of life. When the car breaks down or you fall ill, you'll be able to pay for expenses without taking out expensive loans. While this doesn't make a crisis any less taxing, you'll find yourself more financially resilient in the aftermath.