Strong personal financial plans are built on the foundation of emergency savings. Budget management may be stressful, especially if an unforeseen need arises. Fortunately, there is a method to plan for financial crises that may arise.
By building up a savings buffer—called an emergency fund—you can be prepared to pay for unexpected emergencies without having to turn to credit card debt, family loans, or other borrowing options that create unnecessary stress.
Before we break down exactly what an emergency fund is, let’s define what it is not:
It is not used for planned purchases like a house, a new car, a college education, and so on.
It does not have to a large, unattainable amount; it can start small.
It is not a set amount for everyone—it varies based on your lifestyle.
How Big Should Emergency Fund Be?
While an individual's emergency fund will differ depending on their circumstances, most financial experts believe that a fully stocked emergency fund should be able to cover three to eight months of monthly costs.
Build a Small Fund First
The first step in building a fully stocked emergency fund is to start a small emergency fund of $500 to $1,500. This modest objective is much easier to achieve, and it will make you feel successful after you reach this fantastic financial milestone.
Once you establish the small emergency fund, you can handle life’s small emergencies without going back into debt. This allows you to focus on gaining momentum when it comes to saving money rather than switching back to focusing on paying off debt incurred by small emergencies.
Why You Need an Emergency Fund?
You may believe your job is safe or that you work in a high-demand industry where you can find work fast. You may believe that using a credit card as an emergency fund is sufficient because you can always use a credit card with a 0% introductory interest rate on balance transfers until the debt is paid off.
Unfortunately, everyone will likely face at least a few financial emergencies in their life. Here are a few examples that should help you change your mind so you start building an emergency fund.
1. In case You Lose Your Income
While most people think about being fired, that’s not always the reason you end up losing your income. What happens if you suddenly find out you need to move across the country to help care for a family member because they fell and broke a hip?
What would happen if your company suddenly gets bought out by a larger company, your department becomes redundant and you get laid off?
2. Medical Emergencies
Of course, emergency funds don’t just cover you in the case of job loss. Other major financial emergencies can pop up as well. You may come down with appendicitis and have to pay your $3,000 deductible on your health insurance to get the necessary surgery.
Where to Put Your Emergency Funds
We like keeping our emergency fund in a high yield savings account or a money market account. This way, you have almost instant access to the money when you need it.
Additionally, high yield accounts allow you to earn at least a little bit of interest to try to ward off the effect of inflation.
It often makes sense to keep your emergency fund at a bank separate from your main bank accounts. That way you won’t be tempted to dip into your emergency fund for everyday expenses.