Emergencies happen to everyone. It doesn't matter what your background is, how much money you have, or how financially organized you are. At some point (probably at multiple points), some big, unexpected expense is going to complicate your life. But your financial preparedness makes a huge difference in your ability to weather the storm.
Everyone should have an emergency fund that has between three and six months of living expenses to protect them from these kinds of shocks. Here's a closer look at why and how to build a robust safety net.
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1. You can't control everything
Even the best-laid plans can get derailed. You or a family member might become sick or injured, racking up hefty medical bills and forcing you to miss work. You might lose your job and need to pay bills for a few months while you find a new one. A natural disaster could wipe out your home, leading to a costly insurance claim. Your car or furnace will inevitably kick the bucket, and you'll need a new one. Some of these scary scenarios may never happen to you, but if you bank on good luck, you're putting your family's financial security at risk.
2. You might have to take on debt otherwise
Without an emergency fund, you'll have no choice but to borrow money from family or friends, take out a loan, or charge big expenses to your credit card to cover the costs when emergency strikes. Depending on the size of the debt you take on and how much cash you have left after paying bills each month, you might never get out of that cycle once you get into it, turning a single emergency into a life-altering calamity.
3. It could prevent you from saving for your other goals
That special gift you were going to buy yourself, or the family vacation you were planning? Gone. Without an emergency fund, you'll have to reallocate all your extra money toward the emergency or whatever debt you incurred because of it. If it impedes your ability to save for retirement, you might have to work longer or rely heavily on your children in your old age.
How to create an emergency fund
Now you know why you need an emergency fund. The next step is creating one. You should aim for at least three months of living expenses, but it's up to you to decide what to include in that. It might include all the expenses you typically incur in a month or only the ones you absolutely need to survive, like food, your rent or mortgage payment, and utility bills.
It's fine to limit your emergency fund to just the essentials, but if you have to rely on it down the road, especially if you're out of work for an extended period of time, you might have to tighten your belt.
Three months of living expenses is a good start, but six months is better for a little extra security. Whichever amount you go with, make sure you have at least enough to cover your insurance deductibles if you have to file a claim.
Building your emergency fund should be your top savings priority, even above debt repayment (except for minimum payments to avoid late fees). Decide how much you can afford to put toward your emergency fund each month and keep doing it until you reach your goal. If there are two income earners in your household, each person can provide a portion of it.
If you're struggling to save enough for an emergency fund, look for areas to reduce your spending, like dining out less. You could also start a side job or sell items you no longer use. A few sacrifices now could save you later.
Keep your fund in a savings account with easy access. Don't invest this money or you'd risk losing money in the short-term. (You should only invest money you don't need for at least three years.) If you're tempted to spend the money, place it in a separate account apart from your other savings so you don't confuse the two.
Keeping your emergency fund up to date
If you draw upon your emergency fund, you'll need to replenish it. You can fall back on the strategy you used to build the fund in the first place until the balance is back where it should be.
You should also reevaluate your emergency fund after a significant change, like the birth of a child or an aging parent moving in. Anything affecting your monthly living expenses, in turn, impacts how much you need to keep in your emergency fund. A periodic review lowers the risk your fund falls short of what you need. And even without major life changes, inflation drives up the cost of living over time, so look over your emergency fund at least once a year to ensure it's sufficient to protect you.
Typically, people don't want to spend money on amassing an emergency fund, but when they need it, they're really glad they did.
