Your car breaks down. You need emergency medical care. Your sewer line breaks. What do all of these life situations have in common? They’re unpleasant and unexpected, catching you (and your budget) by surprise. When situations like this occur it’s easy to feel powerless and stressed out if you don’t have the cash. You might have to scramble and tap credit cards or have to get a loan from family. It’s occasions like these when having an emergency fund becomes so important.
Life before an emergency fund
For a long time I too didn’t have an emergency fund. In college and graduate school, I didn’t think I needed a savings cushion because I wasn’t paying for most of my expenses, my parents were, and I knew they would bail me out if I really needed it. Early in my professional life I figured that my 401k was all I needed to for savings — what was the point of saving money on top of that? Never mind that I had accumulated a good deal of credit card debt — it was at a low interest rate, so it didn’t matter right? I kept maybe a few weeks worth of expenses in my checking account, enough to cover my bills… and I spent the rest.
Then something changed. I started watching Suze Orman’s show and as I listened to her advice I began to realize that wow, I might not be able to truly afford all of these things I’m buying. Every time I had a large one time expense I would have to put it on credit. I had no savings to speak of. I was income rich and balance sheet poor. I resolved that I would create an emergency fund — below are some tips I’ve learned along the way.
How much should you keep in an emergency fund?
If you’re just getting started, there are a couple schools of thought on how much you should keep in an emergency fund. Dave Ramsay recommends having a $1000 buffer as a goal to work towards as you begin saving. Once you’ve worked this up, estimate your monthly essential expenses (ie cut out eating out, manicures and other expenses that you could eliminate if you really need to). Many financial planners recommend 3-6 months of essential expenses and Suze Orman recommend 8 months coverage. The rationale is that if you lose your job in this economy, it may well take you many months to find another income source.
Where should you set it up?
For my emergency fund, I set up an account at Ally Bank, an online bank that offers high yield savings accounts. There the money is just far enough away from my Bank of America account that I’m not tempted to cash in on it and just close enough that I can transfer some money into my checking to cover true emergencies.
When has having an emergency fund helped me out?
When I needed a new roof last fall.
When there was a crack in my sewer line and a section of it needed to be replaced last winter.
When I had unexpected car troubles.
When I had to have emergency surgery last spring.
These kind of random expenses come up every few months and it’s ideal to have an emergency fund to cover them. Start small and “pay yourself” by creating a weekly transfer out of your account. You can also set up your direct deposit so that funds are directly transferred into your account. Try $25, $50, or $100 a week and you’ll be amazed by how fast your emergency fund grows!
Thanks to the Carnival of Debt Reduction for including this post in their weekly roundup. Check out the other articles!
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