June 21, 2018. By Courtney Summa:
Life is full of adventure and surprises. Unfortunately, not all the surprises are good and can often result in significant financial distress. When those inevitably pop up it’s always nice to have a safety net to fall into, which is why establishing a dedicated emergency fund is so important.
An emergency fund is ideally a separate bank account to which you have set aside money to cover unexpected expenses. These can include emergencies such as major home or auto repairs, unforeseen medical bills, or sudden loss of income due to a layoff. This financial safety net helps keep your everyday life running smoothly while weathering the emergency, instead of having to rely on credit cards or loans to supplement the surprise payments and financial outlay needed.
How large should your emergency fund reserves be? The answer to that question varies based on one’s financial circumstances and obligations. The general rule of thumb is to save enough to cover three to six months of living expenses (i.e. non-discretionary spending), which include housing, food, utilities, transportation, health care, and debt payments (such as student loans, although Federal student loans may allow for a temporary hardship forbearance if you experience a drop in income). If you experience a major financial crisis like loss of a job, the emergency fund will allow necessities to be paid for during the search for income replacement. Depending on lifestyle, however, sometimes three to six months of expenses isn’t enough and more funds are needed to survive a major expense outflow or loss of income event. Of course it is always best to err on the side of caution and save more than less, however if funds are already tight, then start small. Putting a little something away now, however insubstantial it may seem at first, and building the funds consistently over time will enable you to eventually reach your goal.
Some ways to build your emergency fund include:
- Create a monthly savings goal. Either make a habit of transferring funds to your savings account each month or specify an automatic transfer directly from your paycheck to your savings account each pay period.
- When tax season rolls around, save your refund if there is one available to you. It’s an easy once a year way to build or boost your emergency fund, or replenish it if you’ve had to dip into it.
- Periodically reassess your saving contributions and gradually increase the contributions you make monthly. Steadily increasing your contributions will help your safety net grow at a more manageable rate.
It is always best to keep your emergency funds in a bank account that is separate from the primary checking account you use daily. You may even consider opening an account in a different bank so that you’re not tempted to use it for your daily expenses or occasional splurges. On the other hand, emergencies can happen at any moment, and the funds are only good to you if you can quickly and easily access them to mitigate the situation. If holding funds at another institution from you primary bank, make sure free electronic transfers are available to easily move funds as needed. The important balance to strike is having your emergency funds accessible on short notice, yet not so easily accessible that it is tempting to spend them on discretionary items.
Lastly, it’s important to remember that an emergency equates to a severe financial crisis, like a car breaking down beyond repair or the inability to work due to health reasons. Emergencies do not include holiday and birthday shopping, taking advantage of a “great deal” on household décor or electronics, or any manageable recurring expenses. Draw a line between the account that you have for emergencies and more general “discretionary reserves”, which can be another savings account for fun splurges like vacations and shopping, funded once you’ve reached your goals for your emergency fund.
Life is full of unexpected twists and turns, and everyone needs to save for those emergencies. Having dedicated emergency reserves can often make the difference between surviving a short-term financial ordeal and going into insurmountable debt. If you would like guidance or are at a roadblock with your emergency savings, consider a Quick Start Consult to start saving strategically and inline with your cash flow.