You’ve probably heard someone tell you that building an emergency fund is important, but do you really understand what it is and why you should have one?
An emergency fund is money that is set aside to cover an unexpected expense in the future. These can include:
- Loss of a job
- Emergency medical bills
- Heating system failure
- Leaking roof
- Expensive car repairs
- and more
How much should you put away?
The amount of money you would want to save can vary from situation to situation. However, the standard thought is to save six (6) months of salary. Another option is to save enough money to cover six (6) to nine (9) months of expenses. You can even be more conservative and aim to save enough to cover a whole year of expenses.
So, why is an emergency fund important? Dealing with unexpected expenses is difficult enough, but it can be much harder if you are forced to use a credit card or loan to cover those expenses. This puts you in a situation where you will be accruing interest on the loan, making the total cost much higher than if you were able to pay it upfront. With an emergency fund you can weather the storm without the possibility of it becoming much worse than it is. It can also give you peace of mind knowing that you can handle life’s future financial challenges.
This savings cushion should be set aside from your regular accounts and not considered spendable for everyday things. For example, this is not the same as a vacation fund. If you use this money for things that you can avoid and are not emergencies, it can leave you vulnerable for when something occurs. For your emergency fund you would want to keep it as liquid as possible. This means it is best not to invest it in things that are hard to liquidate on the spot such as certificate of deposits, automobile, or a house. This is because if the money is not there when you need it, then it cannot serve its purpose. This money needs to be accessible at a moment’s notice, so it is best to keep it in a high-yield savings account if possible. Look to make sure the credit union or bank is NCUA, or FDIC insured when deciding on an account.
Now you know what an emergency fund is and how it can help you in difficult situations, here are some tips to begin building one of your own.
The most effective option for some individuals is to have a portion of each paycheck deposited into a separate account for your emergency fund. This will help you build up your emergency fund without even thinking about it. Another way to set money aside for an emergency fund is to treat it as if it is a bill. This helps you set the money aside and be more diligent on making your contributions. The amount you will want to set aside each month depends on how much you have free in your budget. It is best to try and put away the same amount each month, but if things get tight one month just try and put whatever you can. If you are only able to contribute $10 to your fund one month, it still gets you $10 closer to your goal savings.
Other ways to increase your savings is to put away unexpected income into the account. For example, this could be a tax refund, a raise, end of year bonus, or even credit card cash back. Any additional savings will help you get to your goal sooner and allow you to increase contributions for things such as a that vacation you’ve been dreaming of, you dream house, or retirement!
Start your savings goals today!
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