How Much do you Need in an Emergency Fund?
Emergencies such as job loss, unexpected damage to your home or an accident can harm your finances if you haven’t properly prepared. As unavoidable as they are, emergencies don’t have to be financially devastating, as long as you are prepared with an emergency fund. Below are steps to help you familiarize yourself with emergency funds so you can start building your own.
What is an Emergency Fund?
An emergency or contingency fund is an accessible savings fund specifically set aside to offset an unforeseen expense. The fund is separate from long-term savings plans like a college savings or retirement. Rather, the funds are placed aside as a safety net only to be used when an unexpected event requires it. Examples include job loss, extensive home damage or a medical emergency.
How Much Should you Save?
Experts recommend saving three to six months’ worth of planned expenses for an emergency fund, so the necessary amount will vary by household. Start by calculating what you need to pay all your bills including housing, utilities, insurance and debt. Then include necessities such as groceries and transportation for a month. Do not include recreational expenses like entertainment, dining out or non-essential shopping as these are items you can forgo. Multiply the monthly amount needed by the amount of months you want to cover, and that will give you the minimum amount needed for your contingency fund.
It’s unrealistic to believe that everyone has these funds set aside, so don’t panic if you don’t have your emergency fund yet. You should set a reasonable budget that helps you save weekly, bi-weekly or monthly. Don’t be discouraged by the amount needed for your emergency fund. Follow a plan to save over time to reach your goal. Modifications to your savings should be made based on changing responsibilities such as paid off vehicles, debt reduction and other family dynamics. On the other hand, expanding your savings is important when certain scenarios arise like an impending recession, market fluctuation or if you are in an industry where layoffs are common. If you need help with choosing the right budget to build your emergency fund, review our blog Finding the Budget Style That Works for You.
Where Should You Keep Your Emergency Funds?
Unlike other savings and investments, you want to have your emergency funds completely liquid, meaning they are immediately available to you without tax implications, fees or penalties. These funds should be placed in a separate money market or other interest earning savings accounts. The reason you don’t want these funds to be in stocks, mutual funds or long-term certificates is that in an emergency, you need funds immediately and these type of accounts often have fees or a waiting period. Researching your current financial institutions interest earning savings accounts is important so you know you have your funds earning you the most interest. For more information on SDCCU’s savings accounts and rates, visit sdccu.com/savings.
When is the Right Time to Use it?
You want to withdraw from your emergency fund only when you have an expense due to an emergency that you cannot cover with the funds from your normal checking or savings accounts. Once you have used funds from your contingency fund, set a goal to replenish it as soon as you can.
Emergencies never happen at convenient times, and it’s always a good idea to ensure you are prepared for the unexpected. A contingency fund will ease your worries if you prioritize being prepared for a financial emergency. Get started on your emergency fund sooner rather than later to help your future self be more equipped for unexpected life events. Visit our Financial Knowledge Blog to learn more tips on setting up a solid financial future or join us for Financial Wellness Wednesdays.