A recent study shows that 40% of Americans do not have enough money to cover a $400 emergency, according to the Federal Reserve Board. They would either need to borrow or sell something to cover the cost. How would you cover a $400 emergency? In order to deal with an unexpected cost or repair, you need an emergency fund.
An emergency fund is a pile of cash of 3-6 months of expenses set aside for the use of emergencies. It acts as a cushion between you and resorting to borrowing money.
The emergency fund is not a rainy day fund. It’s a “storm produced tornado force winds and now there is daylight peeking through the walls of my home” kind of fund. The fund is for unexpected job loss, medical expenses or repairs. Or, you know, a global pandemic.
This pile of cash is not for investing. It is a life raft in a financial storm. It is insurance. (Just like the homeowner’s insurance you best be paying to fix those holes in the wall.) Put it in a separate bank account and forget about it.
You want these funds to be readily available but not easily accessible. What do I mean by that? Put it in a savings account that does not have debit card access. Label it EMERGENCY ONLY or DO NOT TOUCH (yes caps, for added effect).
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Be Prepared
When you have an emergency fund in place, you may find that you no longer have as many emergencies. This is due to two reasons. The first: you have the money to deal with these events so they become less like earth shattering catastrophes and more like setbacks.
The other reason is when you have the money, you may be more critical of what you would classify as a real emergency.
When I was in the hospital giving birth #nobigdeal, they stuck a needle in my back and gave me a button to press when I wanted a dose of pain relief. The hospital switched to a self-administered pain medication system because they found women were using less pain medication. And no, it’s not because delivering a baby magically became less painful.
Pain is a mental game. We want to push ourselves. Before playing your “get out of pain card” you ask yourself, “Is it that painful?” Maybe a little bit longer. We get into this mentality of saving it for when we really need it.
Same goes for an emergency fund. Once you’ve saved your hard earned dollars, you may be more critical of what you would call an emergency. You ask yourself, “is it that big of an emergency?”
Instead of getting a new phone when your screen cracks, you may find yourself more willing to put up with it, or buy a used phone instead of getting a new one on “retail installments” (fancy phrase for monthly payments).
How Much
Depending on the financial adviser you choose to follow, opinions vary widely on when to save this. Dave Ramsey suggests saving a $1,000 “starter emergency fund”, paying off all debt while only keeping this $1,000 to your name , and then fully funding it during Baby Step 3 once debt is paid off.
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Depending on your comfort level, this may or may not be enough of a cushion. If it were me, I’d like to have a little more saved before going completely hog wild at debt payoff.
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A general guideline for a good (fully funded) emergency fund is 3-6 months of expenses. This time frame is set in the case of a job loss, you’d be safe for 3-6 months while you look for another job.
First, you need to decide how many months you want to save. If your household has 2 or more incomes, the loss of one job may not be as critical. Also, if you were able to find another job with similar pay and benefits relatively quickly, 3 months might make sense.
If you are a single income family, the loss of that one income could be devastating. Also, if you have dependents (kids, elderly parents) or anyone in your family has a medical condition, you may want to lean towards 6 months.
Let’s pick 6 to be on the conservative side. To get a quick ballpark figure, look at how much you make after taxes each month. Multiply that by 6. Here’s an example.
According to the U.S. Census Bureau, the median household income is around $60,000. I used this calculator to figure out the taxes paid.
After taxes, $48,700 is left. Now if we divide that by 12, we get about $4,000 ($4,058) per month. To have a healthy emergency fund, you could save 3-6 months worth of pay: $12,000 – $24,000. With our example of 6 months, you would need to have $24,000 sitting in your emergency fund.
That may seem like a lot to have just sitting in a bank account, earning minimal interest. If you are truly in emergency mode, you probably won’t be spending your entire income every month.
You may opt to put a few things on pause, like saving, traveling, eating out, shopping, etc. so you can deduct those from your target emergency fund number.
Figure out what amount you need to sustain your lifestyle. The necessities are: shelter, food, transportation, and clothing.
Shelter
If something happens and you are without pay for a few months, you still need a place to live. In order to keep a roof over your head, you need to continue your mortgage or rent payments. If your housing costs $1,000/month, you’d need to set aside $3,000-$6,000.
But, a mortgage/rent payment is not the only factor associated with housing costs. You will still need to pay utilities, including phone + internet, and set aside money for home maintenance (unless you already have a separate maintenance fund) if you are owning.
If you are looking for ways to save money on utilities, especially during an emergency, check out my video and post on 18 ways to save money on your heating bill.
Food
Even in an emergency, you’d still need to eat. You can expect your grocery budget to stay the same, but you could cut out your “out to eat” budget. Remember, you are in emergency mode. If job loss is involved, you may be home more and able to cook your own food.
Not only should you have an emergency fund, but also an emergency store of food on hand. Here’s how to stock up your pantry in case of an emergency.
Transportation
Getting from point A to point B is necessary, especially if you need to drive around looking for jobs. You’ll still need money for gas, insurance, and maintenance. Be sure to factor in your car payment if you have one.
Clothing
You won’t need a huge clothing budget in an emergency because you could probably get by with the clothes you have for 3-6 months.
A few exceptions would be for kids that are growing out of their clothes or if you need work/interview clothes to aid in looking for another job. Other than that, you really don’t need to be going on a shopping spree or keeping up with the latest trends while you are in emergency mode.
If you still need to do a little shopping, try thrift stores. Check out my thrift store shopping video.
Shelter, food, transportation, and clothing are the basic needs that still need to be covered in emergency mode. Modern lists include: healthcare, education, sanitation, and internet.
If you don’t want to slash your “out to eat” budget or refrain from doing extra things, account for that when budgeting for your emergency fund.
Too Little VS Too Much
There is a danger that comes with under funding your emergency fund. You could burn it up before you are able to find a new job thus needing to resort to debt. Emergencies are tough enough as it is and the last thing you want is added financial stress.
There is also a downside to over funding your emergency fund but it is less serious in the short term. Because an emergency fund is insurance that sits in your bank account, those dollars are earning minimal interest.
That is okay because the goal of this fund is easy access, it’s not for investing. But, you don’t want to have more than you need because you could be investing the extra. The extra could also go towards a house or car fund.
An emergency fund is crucial for your financial well-being. It is there strictly in the case of emergencies. This is not a down payment fund, or a travel fund. It is for lose-your-job or unexpected-medical-issues type emergencies.
You could save a “starter emergency fund” of $1,000, pay off debt and then save up 3-6 months of expenses. Another option would be to save 3 months of expenses, pay off all debt, then bring it up to 6 months.
The amount you choose depends on your comfort level. Whatever method or amount you choose, make sure you have enough to cover emergencies that arise – as best you can – so you don’t have to resort to going into debt.
Where to begin? Start by saving. Here are money saving challenges you can start today!
More Ways to Save:
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