After a horrific 2020 year, which made deep dents in our financial pockets, it’s more important than ever to have an emergency fund.
Keeping some buffer money with yourself is no less than a luxury when the world sees massive layoffs, unemployment and loss of income.
Having some additional funds to deal with life uncertainties is one of the underrated luxuries that fewer people enjoy. This saves you from borrowing more money at high-interest rates and staying out of debt.
In this article, you’ll learn everything related to emergency funds, it’s importance and how much you need.
So, sit back and keep taking notes.
- What Is An Emergency Fund?
- What Is The Importance Of Emergency Fund?
- Why Do I Need An Emergency Fund?
- How Much Emergency Fund Do You Need?
- Where Should I Keep My Emergency Fund?
- Start Building Your Emergency Fund Today
- Emergency Funds FAQ
What Is An Emergency Fund?
In simple language, An Emergency fund is a stash of money set aside to cover unexpected expenses in life. It is also known as a Rainy-day fund.
Life can test you with uncertainties at any point in time; that’s why it’s essential to start saving some money as early as you can.
Some unplanned expenses which can knock on your door at any hour:
- Home maintenance and repair
- Car breakdown
- Medical expenses for an unexpected illness
- Sudden job loss
- Any miscellaneous expenses
Something to note here is, your emergency fund is not meant to be spent on non-essential spendings. Often, you’ll have an urge to buy movie tickets, take a vacation, buy clothes, new phones, etc. But at all costs, you need to protect your rainy-day fund for rainy days only.
What Is The Importance Of Emergency Fund?
Life is a combination of ups and downs. To deal with the downs in your life, you need to be prepared both mentally and financially.
While you might have enough money to save yourself from unplanned expenses, an emergency fund provides you with a cushion of relief. The recent Covid-19 pandemic is the perfect example to understand the importance of having an emergency fund.
With some extra funds in your pocket, you can sleep peacefully knowing that you’re prepared financially no matter how life treats you in the near future.
Also, during difficult times, this fund can help you afloat without relying heavily on high-interest credit cards or loans. If you’re paying down borrowed money and suddenly lose your job, an emergency fund can help you avoid borrowing more.
Why Do I Need An Emergency Fund?
Many people argue about the necessity of having an emergency fund.
Well, you might say, I earn more than enough to counter any uncertainties of life. Why do I even need this fund?
See, it’s not something that should be a mandatory part of life. However, having some extra stash of money will always be good for you, just for any unplanned expenses.
Many research suggests that individuals who struggle financially always find it hard to deal with future emergencies. They max out their credit cards, borrow money, and end up in a significant debt which takes years to eliminate.
According to Bankrate, 51% of Americans have less than 3 months worth of expenses covered in an emergency fund. 25% of Americans say they have 6 months worth of the costs covered for unplanned emergencies.
And, do you know what happens when you don’t have an emergency fund?
You end up taking high-interest loans, and worst, break your retirement and 401(k) accounts in quest of money.
How Much Emergency Fund Do You Need?
Every individual has unique expenses and savings depending on their style of living. Hence, the actual amount of savings you need to build your emergency fund will vary from person to person.
While you can stash as much as you can in your emergency fund, it’s essential to know how much minimum amount you need to avoid any unexpected expenses.
Remember, your rainy-day fund will protect you from uncertainties like job loss, home repairs, car breakdowns, etc. Ensure you should not include any luxury expenses in this fund.
The good rule of thumb is: the more stable you’re in your job and assets, the lesser amount you need in your emergency fund.
For example, if there are two earning members in your family and have a stable income for years, then you are good to go with only 3 months worth of expenses covered in your fund.
On the other hand, if you’re a sole earner and doing a part-time job, you need at least 6 to 9 months worth of living expenses.
There are 3 steps to calculate the estimated amount you need to build your emergency fund:
- Calculate how much your monthly expenses are (excluding luxuries)
- Multiply your monthly expenses with 3/6/9/12, depending on your current situation. This will give you your “Emergency Fund Number (EFN).”
- Check how much you have in your savings and Subtract your current savings from your EFN
You can also try our Emergency Fund Calculator to find out how much amount you need to build your rainy-day fund:
Where Should I Keep My Emergency Fund?
Now that you’re saving every month to build your emergency fund, you might be thinking, where should I keep it.
Before discussing that in detail, first check out some common mistakes to avoid related to your emergency fund:
- Please do not keep it in an account that takes more than 24 hours of the withdrawal process
- Never lend your fund amount to your friends, relative or anyone
- Never spend it on luxury items like buying clothes, vacations, new phones, etc.
- Do not use it in stock markets or lottery
- And most importantly, never let it slip down to zero
Always remember that this fund amount is to help you in your emergencies. So, try to keep it as liquid as possible. By liquid, we mean that you should be able to access your funds easily and quickly.
Try to keep your fund in a separate account that has stable interest rates with minimal exit charges. You can also split it in a 50:50 ratio. Put 50% of your overall fund amount in your bank so that it earns some interest to grow more, and put 50% of the amount with yourself to deal with sudden overnight expenses.
According to financial experts, people who have an emergency fund, keep it separate from their checking and savings accounts. This is just to ensure that they do not use it for unwanted spendings.
Related: How To Create Generational Wealth
Start Building Your Emergency Fund Today
Imagine a life with no debt and 6 months worth of living expenses saved rightly in your emergency fund. You can sleep peacefully with no financial stress.
How does it feel to you?
Yes, you can be in that place as well. Just aim that you’ll start building your emergency fund from today only, and you’ll achieve your target in less than a year.
An emergency fund is like an Insurance Policy, you pay the premium and get the cover to save yourself from sudden life mishaps.
Cut down your unnecessary spendings for a few months, pay off debt, build a budget, and you’ll be all set. Make it a priority in your life to improve your finances.
Remember, The best time to save money was yesterday, and the next best time is TODAY!
Emergency Funds FAQ
Here are a few common frequently asked questions (FAQs) regarding the necessity of emergency funds.
Why Do I Need An Emergency Fund?
The simple answer is: to avoid falling into debt.
When individuals have zero savings and see themselves in panic situations where only money can save them, they try to borrow high-interest credit card loans that later become a big debt.
Having a buffer amount helps you avoid this debt cycle and make your life a little easier.
How Much Should I Save Per Month To Build My Emergency Fund?
It depends on your needs and way of living.
Let’s look at an example that will help you understand how this works:
Suppose your monthly expenses are $4,000/month and you work in a part-time job. According to the current market situation, you need at least six months worth of living expenses to sustain your lifestyle in case of sudden job loss.
So, you need $24,000 in your emergency fund to live a similar life for six months, even if you lose your job. If you’ve $5,000 in your savings, you only need to save $19,000 more to build your emergency fund.
To achieve this money target, you need to save $1,600 per month to reach your goal in the next 12 months.
Is $1,000 Enough For An Emergency Fund?
Yes, if your monthly expenses are minimal. No, if you’re a high spender.
$1,000 will save you for a few days, but something is better than nothing at all. So, start with baby steps. Saving $500 per month is a good start to build some buffer for life uncertainties.
Hope you liked this article. Let us know in the comments how you’re planning to build your emergency fund and what problems you are facing.
Disclaimer: This article is completely informational and educational and is not meant to constitute legal, tax, or investment advice. You should always consult with qualified financial experts and tax professionals regarding your specific situation. Keep in mind that investing contains equal risks and rewards. The value of your assets will fluctuate, and you may gain or lose money over time.