Emergency Funds are like Spare Tires
Emergency Funds Are Like Spare Tires...
Emergency funds are like spare tires: you never think about them until you need one. This is an unfortunate truth for many people who don’t have a rainy day fund saved up for themselves. Some people fail to see the advantage in creating a fund, while others want to create one, but don’t know how. Creating an emergency fund is more important, and simpler, than many people believe.
Why do you need an emergency fund? This question can be answered easily by anyone who has ever needed one. Life is unpredictable, or as I say to my clients, “life happens”. The situations that could arise causing a need for an emergency fund are almost endless: healthcare, car troubles, property damage, emergency travel, or, as many people in recent years have encountered, job loss. It’s much easier to roll with these punches if you have prepared for them in advance!
The amount needed in this fund varies according to your situation and lifestyle. Contingency plans are most successful when you plan for the worst case scenario, which in this case, is job loss. You need to create a monthly budget of your expenses in that case that you suddenly find yourself with no income.This means your rent or mortgage payment, food, utilities, insurance, debt payments, prescription medications, and so on. The bare minimum amount in your emergency fund should be equal to three months-worth of these expenses. The overall goal is to have six months of your expenses available to you in the fund. This may seem intimidating at first, but every little bit helps, so put in what you can over time, and aim for that target number.
With banks paying little to no interest on our savings, many people ask me where they should “invest” their emergency funds as they accumulate. My answer is that these are the funds you want to have un-invested and available! Most emergencies don’t allow for the time needed to access money in some investment accounts. You should be able to access your funds within one business day. This is the case with traditional savings accounts or money market accounts. These are the funds for your bank around the corner.
Another suggestion in creating an emergency account is to cut into your long-term investment contributions. 401(k)’s and IRA’s are critical to your long-term future, but if you are walking around with a great long term, and nothing for the short term, you could find yourself in some trouble. This doesn’t mean you need to take thousands from your retirement contributions, but a little each month until you have yourself protected isn’t going to drastically affect your plans 20 years from now, but it could be lifesaving in just a few.
One of the easiest ways to protect yourself in an emergency such as a job loss is to take care of what expenses you can eliminate ahead of time. This means paying off debt. The debt on high interest credit cards can get a lot more painful if you don’t have an income. This not only cuts down on your expenses,but if you’re paid up to date, you allow yourself some room if you need to use those credit cards as a source of financing in an emergency.
The two most important aspects of creating an emergency fund is having the foresight to know you might need one and having the discipline to be able to create one. If you have those two things, the rest is easy. Just account for your monthly expenses, plan an account to funnel money into, and budget your income to allow that account to grow.