Life is full of emergencies and crisis. In fact, if you are above ground and sucking wind, there is a very high probability that you will experience a life crisis. Job loss. A sudden death in the family. A major medical emergency that lands you in the ER. Nobody wishes for these things to happen, but we need to be prepared for when these events happen, not if they happen. Having an emergency fund takes out the additional financial stress of a crisis out of the picture so that you can focus on the real crisis at hand.
How do you get started building an emergency fund? Here are my suggestions to build an emergency fund that will provide you the security and peace of mind you need during trying times:
Start small. Trying to build a fully funded emergency fund can seem daunting and impossible. What makes it more frustrating is when you have to dip into the fund before you get it fully funded. Remember that your emergency fund is there for emergencies so even if you are depleting it before you get to your goal, it is serving its purpose! Start with a small goal of $1,000 or $2,000 to get you started. Once you reach that goal, increase your target amount. Setting smaller goals will make the overall total emergency fund goal attainable.
Keep your emergency fund in cash in an accessible account. The whole purpose of having an emergency fund is that you can access funds quickly without any penalty. Relying on credit cards for emergencies means you will probably end up incurring interest that will add more pain to the emergency. A certificate of deposit restricts you from cashing in your funds before a specified period. And don’t even consider stocks or a mutual fund for an emergency fund – there is too much risk you are taking on to have funds available. Park your emergency fund in a plain old savings account or money market account. It doesn’t sound sexy but look at your emergency fund like insurance rather than an investment opportunity.
Set your emergency fund goal to be three to six months of household expenses. Notice that I stated three to six months of expenses and not three to six months of income – there is a difference between the two. The biggest question I get is should the emergency fund be closer to three months or six months? My answer: it depends. It depends on your job security and your risk comfort level. Being a freelancer and knowing I don’t have a spouse that I could have as a safety net, I lean towards the six-month amount. You need to come up with an amount that you feel would cover a major life event if it happened.
Remember that emergency funds are for true emergencies. You need to make sure you are defining an emergency appropriately. An emergency is not a shoe sale at Nordstrom. An emergency is not a last-minute trip to the Caribbean because you need to get away from the winter weather. An emergency is not for routine maintenance for things around your home or car – you should be creating separate savings for those expenses. But a leaky roof or a last-minute plane trip to say goodbye to a dying family member or a major medical event or a job loss – those are true emergencies.
Have you started an emergency fund? If not, what has kept you from doing so?