Published in: Banks | Sept. 25, 2019
By: Christy Bieber
Is your emergency fund below where it should be? Here are some red flags that suggest you need to add more cash to this all-important account.
You probably already know that having an emergency fund is really important. After all, saving up cash for emergencies is one of the most common pieces of financial advice that you'll hear.
But when it comes to the size of your emergency fund, it's a little harder to figure out what balance is best. Most experts recommend you have between three and six months of living expenses, but this is a pretty wide range. And if you're working on paying off high-interest debt, you'll probably hear that you should have a smaller emergency fund until your consumer debt is paid down.
It makes little sense to have six months of cash in the bank while paying a fortune in interest to creditors.
If you've got an emergency fund but just aren't sure whether there's enough cash in it, here are some red flags that suggest your fund is not big enough to cover unexpected expenses or financial disasters.
The point of an emergency fund is to help you stay out of credit card debt. If your fund is so small that you can't cover even the most minor of emergencies without reaching for your credit cards, this is a major problem.
You'll need to work on saving up a bigger emergency fund ASAP -- even if you are also trying to pay down debt at the same time. Otherwise, you'll never break the debt cycle because as soon as you make progress on paying down your cards, an emergency will inevitably happen that leads you to charge them right back up again.
If you routinely have unexpected emergencies that cost you too much to cover without borrowing, you need to build up your emergency fund to an appropriate size to pay the costs of the calamities you're most likely to encounter.
Look back at your past six months of unexpected expenses that caused you to borrow and aim to save up an emergency fund at least large enough to cover the biggest of those surprise costs.
One reason why emergency funds are so important is that they can protect you from bigger financial losses. This doesn't only include losing money in interest payments because you have to borrow for emergencies, but also major financial disasters such as foreclosure or repossession.
If you couldn't afford even a single car or house payment without income coming in on a regular basis, you are in an extremely precarious position.
Even the most minor of job setbacks could destroy your credit and set you back financially for years. This is a major red flag that your emergency fund is way too small to protect you.
Figure out how much you'd need to cover at least a few months of your most essential expenses, such as your debt payments, mortgage, and car loans and build up your emergency fund to at least that level.
You can take other sources of income, such as a spouse or partner's salary, into account when determining how much you need to have in reserve to pay those absolutely essential bills.
Emergency funds should also give you peace of mind so you can limit financial stress. If you're lying awake at night worried about how you'd cover bills if a surprise expense cropped up, your emergency fund is not doing its job.
Financial stress can take a toll on your relationships and on your health. If money is causing you undue stress, you need to alleviate your money worries by building up a bigger emergency fund.
It may even make it worth making minimum payments on a high interest debt for a few months, so that you can divert cash, boost the size of your emergency account and give yourself some peace of mind.
The reason emergency funds are recommended so often by financial experts is that they really are important. If you don't have enough cash saved to keep you out of debt and help you avoid dire financial emergencies, it's time to work on building up your emergency savings ASAP.
This should be a top priority and should be where you direct any extra cash after meeting essential expenses.
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