Unlocking the Mystery Behind Saving For Emergencies
One of the most important steps in creating a life of financial stability is to create an emergency fund. There is nothing fun or exciting about emergency savings; it’s like insurance – boring, but necessary. You can think of an emergency fund as insurance for living life.
What is an Emergency Fund?
An emergency fund is a cash buffer that is available to help you pay for any unexpected expense that might pop up throughout the course of everyday living. It’s good to sit down and really brainstorm what these kinds of expenses might be. If your A/C unit goes out in the middle of July when it’s 103 degrees outside how will you pay for an immediate repair or replacement? Hopefully you have an emergency fund set up that can handle this expense so you don’t have to turn to credit cards to get you by. It makes sense to first understand exactly what your emergency fund could be used for before mapping out a plan to start building one. Here are some examples of what expenses could be covered from an emergency fund.
- Unexpected car repairs: These expenses can typically cost hundreds of dollars to fix. These expenses are also ones that have to be taken care of right away in order to have a reliable mode of transportation.
- Unexpected emergency home repairs: Homeowner's insurance should cover most major expenses, but you should understand what is covered and how much you would have to pay out of pocket just to reach your deductible. But keep in mind if your refrigerator gives out that cost comes out of your pocket!
- Health expenses: It’s important to know what your payment obligation will be for any kind of medical treatment. If you have a high deductible health plan or you have a very high max out of pocket limit, it would be wise to have some cash liquid that would cover these expenses if you end up having to have emergency surgery.
- Income replacement due to job loss: If you lost your job tomorrow how would you pay the mortgage? It’s a good idea to have an emergency fund to cover your necessary living expenses for at least a few months should anything happen to your steady paycheck.
- Bigger than expected tax bill: April 15th comes a lot faster than some of us realize. If you wait too long to get your tax information together it could come as a surprise that you have to pay Uncle Sam a larger than expected sum of money without a lot of notice. If you have an emergency fund available you could potentially ease a lot of stress when it comes to writing that big check to the IRS.
- Unexpected travel expenses: A common example of this type of expense would come from an unexpected trip out of town to attend a funeral for a loved one. I know all too well how devastating this can be emotionally and the last thing you need to be doing is stressing about the cost of a last minute plane ticket.
- Emergency pet care: For most of us our pets our part of our immediate family. Many people don’t carry pet insurance so having cash on hand to pay for emergency medical care for your pet is just as important as having the cash to pay for your own emergency health needs.
How Much is Enough?
This is the question that stumps people most when it comes to the topic of an emergency fund. It can seem very overwhelming to think about accumulating large masses of money to have for “just in case” purposes. I understand the concern. While most people understand the importance of saving for an emergency they also want to use their money for fun stuff – things they can actually enjoy. Building an emergency fund should be an ongoing financial obligation. No one expects you to plop down $50,000 before you can justify buying a new piece of furniture or taking your family on a vacation. It can also be heard to quantify just how much you'll need for emergencies since your life situation is completely unique. I was introduced to a cool interactive online calculator that can help guide you on the amount you might need to accumulate for certain emergencies. HelloWallet provides a free interactive calculator that identifies 3 levels of emergency savings including anything from minor emergencies, major emergencies and job loss. I agree that its easier to break up emergency account funding and first start working towards covering minor emergencies, than major emergencies and finally job loss.
Strategies for Building Your Emergency Fund
When it comes to saving for emergencies everyone will have a different amount they need to plan for. In the game of life there are many things vying for the attention of your dollars. How do you prioritize where your money goes first? I've listed a few steps, in order of importance that can guide you on the right track towards building up your emergency fund (while also focusing on planning for your future).
- Create a Cash Buffer: Go ahead and set aside at least $1,000 - $2,000 in your emergency account to begin with. This is an initial cash buffer that helps protect you from living paycheck to paycheck.
- Invest for Retirement: Make sure you're adding money to your company's retirement plan. You should be putting in at least enough to qualify for your employer's full company match. If your company doesn't offer a retirement plan open a retirement account of your own ex: Roth IRA, Traditional IRA or SEP IRA (if your self employed).
- Pay off Bad Debts: GET RID OF YOUR CREDIT CARD DEBT! This might take you a while but in the long run you'll be better off getting out of debt now rather than later. It's nice to pay cash for the things you want and need instead of watching large chunks of your monthly income go towards the things you've already enjoyed.
- Save for Emergencies and Increase your Retirement Contributions: At this point you should be striving towards putting away 15% - 20% of your income towards these financial obligations. Don't put everything towards emergency savings and nothing towards retirement; you'll lose out on teh value of compounding earnings over time. Also, don't put all of your money towards retirement and nothing towards emergencies. You don't want to have to rely on credit cards to pull you out of a tight spot! Consult a professional to help you figure out how you should realistically split up that 15% - 20% of your income you've earmarked towards these priorities. It will be different for each individual since we all have very unique life styles, income and family situations.
When it comes to personal finance, if you're not sure about what you should be doing, please ask! You can ask your questions immediately by shooting me a quick email.