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What is one of the first forms of financial advice you always hear? You need to have an emergency fund. However, Americans don’t seem to be following that advice.
About 40% of people would have to turn to loans or credit cards to cover a $400 emergency. If you have some money set aside to handle emergencies, you won’t have to spend a lot of time looking for funds, and it will save you from adding more debt to your life.
The simple definition of an emergency fund is the money you set aside for an emergency situation to cover any kind of financial shortfall.
Situations like a loss of job, sudden medical expenses, unexpected car breakdown or home repairs are some of the true financial emergencies where you may need to rely on a reserve fund.
It only takes a few easy steps to build an emergency fund for any unforeseen events. And one of the crucial step would be to know how much money should you keep in savings.
Keep reading to find out why you need emergency savings and how to determine how much you need.
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Why an Emergency Fund is a Must
You’re likely to have financial goals. You may want to pay off debt, invest, or buy a home. To reach your financial goals, you need to consistently set aside money for it.
Life happens. You may lose a job or a big contract. The dog may have medical issues. Your car can break down. All of these things require money to get your back on track. Sometimes, they require a lot of money.
If something happens, it can keep you from reaching your financial goals. Even worse, you could be further in debt.
For example, you have a goal to pay off $10,000 in credit card debt. You take out an installment loan to consolidate debt and lower your interest rate. You make the monthly payments consistently, inching closer to your goals.
Something comes up, and you don’t have an emergency fund set up to cover it. You then have to finance the emergency on your credit card, putting you back where you started.
With an emergency fund, you have the cash to handle such disruptions and you can stay on track with your financial goals.
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How Much Money Should I Keep in Savings?
This is the million-dollar question. Most financial experts will say that you should have between 3-6 months of expenses set aside for your emergency savings fund. The amount you should save will depend on your situation and your lifestyle.
Since monthly expenses will vary from person to person, it’s you who needs to decide how much money you would require to protect your family’s living standards in the absence of your income.
A self-employed single person should have about 9 months of expenses saved. That will cover the financial ebb and flow of self-employment, especially if your business is seasonal.
For a two-income household with 2 kids, that will be completely different. You should have enough savings to cover for 6 months.
You could also think about adding unexpected windfalls to this fund. This will shoot up your emergency reserve fund to a great extent.
You may look at that and think that it’s impossible to do because you live paycheck to paycheck. It’s OK to start small.
You can set a goal for a few hundred dollars or $1,000. The main thing is that you’re starting to save.
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Start Your Emergency Fund
When you are working on improving your financial situation, you would want to start by having an emergency fund.
Once you understand what an emergency fund is and why you really need to build one for yourself, the first question you’re likely to ask is, “How much money should I keep in savings?” And that’s what the entire game is all about!
There’s no one number that applies to everyone. You have to evaluate your situation and your expenses. Remember, an emergency fund is not for things you had planned for or to cover the extra cost of a luxurious holiday.
After a while, you could also be tempted to dip into your reserve fund to cover your normal expenses. But this fund should be exclusively used to help you during uncertain financial emergencies like car repairs or medical costs.
If you are honest with yourself, you will be able to maintain your emergency reserve well and definitely not regret ever.
If you are just starting out, there is no minimum or maximum limit to the amount you transfer to your rainy-day fund. At the very least, you want to start saving, no matter how small the amount is.
Once you see your emergency fund growing week by week or month by month, you can get the much-needed boost to save money for probable emergencies.
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I think 6 months of expenses is a good baseline of your emergency savings but to be safe may a year’s worth of expenses that way you have a good stash to have for a while if you’re stuck between jobs. Also, emergency savings should stashed in high yield savings account so you can get some interest added to your account.
I just got hit with an unexpected car repair. That savings would keep me from putting it on my credit card.
I took early retirement several years ago. My income was reduced by half. Before I left my job, I established an emergency savings account. I contribute 10% of my income every month to emergency savings. This account is a financial life saver. From emergency car repairs to replacing a refrigerator and a washer & dryer that quit working to unexpected things as small as a traffic ticket. These all were paid for with cash. Love reading your blog!