Published in: Banks | Feb. 27, 2020
5 Things You're Doing Wrong With Your Emergency Fund
By: Kailey Hagen
You're probably guilty of at least one of these.
Your budget might be the framework of your financial plan, but your emergency fund is its foundation. Without it, everything else comes tumbling down at the first sign of trouble. It's a pretty simple concept in theory -- you set aside money to cover your unplanned expenses so they don't ruin your budget -- but in practice, it doesn't always that way. If you want your emergency fund to be your safety net, you have to avoid the following five mistakes.
1. Not building one
If you don't have any savings to fall back on, an emergency could threaten your financial security. You might have to charge the unplanned expense to your credit card where it'll begin to accrue interest at an alarming rate. Or you may fall behind on some of your other bills, racking up late fees and hurting your credit. The effects of that one emergency expense could haunt you for months or even years afterward.
An emergency fund is the only way to make sure that doesn't happen. You stash this money in a bank account and leave it alone until an emergency arises. Then, you use these funds to cover your costs so you don't have to take on debt or alter your current budget.
2. Underestimating your needs
Your emergency fund should contain at least three months' worth of living expenses. Six months is even better if you want to be extra safe. Include basic living costs, like your rent or mortgage payment, food, insurance premiums, and utility bills. You can also add in things like the cost of things like streaming services if you'd like. You don't have to, but if you choose not to and then end up out of a job for several months, you might have to cancel these extra services.
Those with high-deductible health insurance plans should also make sure that their emergency fund is enough to cover their deductible in case they have a medical emergency. You may want to save a little more than this if your insurance requires you to pay a copay for many services.
3. Spending it on non-emergencies
Your car breaking down might be considered an emergency, but the car's stereo going out isn't. You must make a clear distinction between what is and is not an emergency so that you aren't tempted to spend your emergency fund on non-emergencies. Doing this could leave you short of cash when you really need it.
If you have an unplanned expense that is not an emergency, see if you can save a little money each month until you have enough to cover it rather than dipping into your emergency fund. If you have any extra savings apart from your emergency fund, you could draw upon these as well.
4. Not replenishing your emergency fund after you use it
You must replenish your emergency fund every time you use it so that you're prepared for the next emergency. Look at how much you spent and decide how long you'll need to get your emergency fund back up to full strength. Divide the number of months by the total amount you have to save to figure out how much you must set aside per month to hit your goal.
You might need to make some changes to your regular budget for a few months, like cutting back on discretionary purchases to free up the cash you need. It may not be that fun, but it's better than leaving yourself unprepared for a financial emergency.
5. Not updating it at least once per year
Your emergency fund needs to change with your lifestyle. Having a baby, an adult child moving out, getting a new job, or moving to a new home could change how much you need to keep in your emergency fund. Even if none of these scenarios apply to you, inflation will erode the value of your savings over time, so you'll have to add a little more every year to ensure that you have enough.
At least once per year and every time you experience a major life event, you should reevaluate your emergency fund and decide whether to update it. If you need to add money, budget a little every month until you reach your goal. If you decide you don't need quite as much money as you used to, you can take out some of the extra and use it on things you enjoy.
You probably won't use your emergency fund that often, but when you need it, you'll be really glad you have it. If you don't already have one, start building yours today, and keep it up to date so that you're prepared for whatever costs the unexpected brings.
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