Life happens. It’s as simple as that. No matter how much you plan, it is always a good idea to have some money saved away for when life throws you a curve ball. The term “emergency fund” gets tossed around very often, but the average person in their twenties remains unconvinced of it’s usefulness.
After the jump, I’ll talk about why having an emergency fund is not only a good idea, but how it forms the foundation of your financial security. I’ll also explain how to start building your own emergency fund and when to use it.
Why You Need An Emergency Fund
No matter how much we plan, life can be unexpected. An emergency fund is meant to form a cushion between your financial security and those unexpected events life throws at you.
By building and maintaining an emergency fund, you will avoid debts in the future which might normally be caused by an unexpected expense. Instead of leaning on credit cards and subjecting yourself to high interest debt or incurring any additional late fees, you can now weather a financial emergency debt free.
Additionally, an emergency fund can provide job security in those first few years out of college. Even as the economy gets better, younger or newer employees can face uncertainty in today’s job market. If your employment situation was to change tomorrow, would you be able to afford it? Could you pay rent, buy groceries or make student loan payments? Depending on your work and living situation, the answers to these questions might not be very clear. This is another great reason to maintain adequate savings.
But just how much savings is enough?
How To Start Building Your Emergency Fund
1. Determine how much you need to have saved
General wisdom says that you need 3 to 6 months of essential expenses accounted for in your emergency fund. Essential expenses include: putting a roof over your head (rent/mortgage), feeding yourself and your family, and paying any other fixed expenses (i.e. student loans or other personal loans).
Realize that in case of an emergency, such as the loss of a job, some expenses may diminish or disappear. Plan on eating out less, spending less on a daily commute, going on fewer vacations, and shopping less often. Divide up the “wants” and “needs” in your budget. Determine if moving back in with parents or family would be possible or not. This will all help determine how much you need to save. Generally, 6 months is on the very safe side. If your job is secure, you may be safe enough with 3 months of expenses saved for other unforeseen expenses such as medical bills or car repairs.
2. Open a Savings Account
Okay, so where do you put this money you’re saving? Even though interest rates in a regular brick and mortar bank are abysmal, this is still your best bet for storing money. A savings account in a physical bank is FDIC insured and easily accessible (liquid).
Why use a savings account instead of just a regular checking account? Personally, I think putting up a “mental wall” between my savings and spending money keeps me from digging into my emergency savings for non-emergencies such as a vacation or Christmas shopping. Your mileage may vary and in the end it’s up to your personal preference.
3. Start small and take it slow
Once you determine your savings goal, don’t be overwhelmed by the number. Start with a small goal first. Try to hit just $100, then $500, then work your way up to and past $1000. It doesn’t need to happen overnight. Small changes in lifestyle can snowball into big financial changes.
Don’t be so quick to spend your entire yearly bonus, tax return, or salary increase. Take advantage of this increased cash flow and allocate some (or all) of that money toward your savings.
When to tap your emergency savings?
There are a few questions you should ask yourself before dipping into your rainy day savings. One of them being, “Is it an absolutely necessary expense?” Don’t use your emergency fund just to make a big purchase. Recognize whether it is a need or a want. Is it an unexpected and urgent expense? If it can be put off or paid over time without incurring late fees, avoid using your emergency fund.
Don’t feel guilty for using your emergency fund for an actual emergency. Medial bills, car repairs, or gaps in employment happen. Emergency savings is your cushion against the unexpected.
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