Establishing an Emergency Fund is an essential part of being ready for what life throws at you. This post covers some of the fundamentals and it outlines how you can get started today. It is also the next step in the “Getting Started Series”. After you complete this step, you’ll be more resilient, stronger, and better prepared for surprises in life.
Click here to read more posts in the “Getting Started Series”.
THE FUNDAMENTALS: WHAT IS AN EMERGENCY FUND?
As suggested in the name, an Emergency Fund is specifically for emergencies. A simple concept, it can be more challenging to establish, practice, and maintain. An Emergency Fund is there to cover extenuating circumstances beyond what the regular monthly budget line-item can address. Consider this example: if you lose your job, an Emergency fund such as this can cover critical monthly expenses.
Building an Emergency Fund is part of the core concepts, Mêtis, found through out this blog. It is an essential part of equipping yourself to handle your finances. An Emergency Fund is there to effectively serve as an insurance policy. In the event of an emergency, it is part of being able to provide and care for loved ones. Don’t let life catch you without a plan!
Core Features to Consider
When you go about establishing an Emergency Fund, keep in mind that it should be one that is relative liquid and easy to access. You should be able to access it in 24 hours or less, and there should be no limitations on the amount you can withdraw or cash-out. As an example, avoid using funds that take a few days to settle or otherwise reduce your ability to withdraw the funds.
Instead, focus on a basic Savings or Money Market Fund. The key is to be able to access funds in an emergency. Later in this series, we will cover funds for “Investing Purposes”. Remember, the goal of the Emergency Fund is not “Investing” per se. You should not expect an Emergency Fund to generate an extremely high rate of return. Target diversity in your banking choices, ease of access, and a small rate of return.
Avoid using your Emergency Fund as Savings Account
You might notice your desire to go shopping will increase as the balance in your Emergency Fund grows. Be careful, and establish ground rules for the fund at the beginning. That way, the habit is already established before the Fund has been established. Do not use your Emergency Fund for anything other than an emergency. It is not there to “borrow” or “cover an overage” or act as any sort of “down payment” option.
Don’t Use Credit Cards for Emergencies
As a rule, Credit Cards make horrible Emergency Funds. In the middle of a proper Emergency, the Credit Card offers only a short-term solution (liquidity) in exchange for a very painful, slow, and exponentially more expensive path through said emergency. Credit Card debt is a massive problem to deal with, and I think there are other ways to survive an emergency without creating another disaster for yourself in the form of credit card debt with incredibly high interest rates.
YOU NEED TO START ESTABLISHING AN EMERGENCY FUND TODAY
Now that we have laid some foundational pieces down, let’s look at the practical side of establishing an Emergency Fund. Here, we will talk about the logistics, amounts, and locations to consider for your household and situation.
Budgets are Essential
This Getting Started Series is written in order of importance and each step builds on the previous concepts. Bettering Your Budget is a critical ingredient for establishing your success story. A working, properly functioning budget will command your money into the proper uses. Budgets scale to every unique circumstance, and give you the power to forge your financial profile.
In the Budget, establish an amount that can be directly contributed to the Emergency Fund. It should be automated, and it should be balanced between getting your balance to the desired level (contributing more) and yet not so big that it cripples the finances. This is covered in more detail, below.
How Much Money should be in an Emergency Fund?
Now that the Budget is doing its part to funnel money into the Emergency Fund, the question becomes “how much should be contributed each month, and how much is needed overall?” At first, the monthly contributions should be as much as you can afford. Try to establish the Fund as quickly as possible! I want to encourage you to push hard! Let the amounts taper-off after the initial balance is in place. Aim for $500 as an initial balance, and drive hard to make that happen as quickly as possible.
After hitting the $500 mark, shift gears if needed. If things were a bit tight getting here, then consider scaling back a little. But not too much! Consider adjusting spending habits and eliminating luxury items to free-up cash for the funding of the Emergency Fund. That said, the next tier of the Emergency Fund balance should be approximately 1 month of expenses. This ties-back to the importance of the budget! From a solid budget, the next target(s) are easy to set. As a practical item, remember to trim luxury items out of your budget (example, no going out to eat, etc.) in the event of an emergency. As such, aiming for the the current monthly expenses as a target for the Emergency Fund likely adds a little padding.
Note, if you get a raise or another source of income, or go through a life event that drives-up your monthly expenditures, remember to increase your Emergency Fund target balance accordingly. Before my wife and I had kids our monthly expenses were relatively low. After our first child, the monthly expenses obviously increased which meant we needed to increase the target balance of the Emergency Fund.
What to do after using your Emergency Fund?
In the event of an emergency, the Fund is now ready for action. Just as another reminder, and word of encouragement, make sure the emergency is actually an emergency and save the Emergency Fund for just such an occasion.
If you withdraw funds to cover an emergency, keep track of how much is actually spent so you can pay it back after the emergency. In order for this process to work, the Emergency Fund will need to re-funded at some point post-emergency. If the fund balance is $1,000, and the emergency is fully addressed with $200, then you should focus on paying the fund back those $200 in the following month. Doing so will restore the full balance (the monthly expenses amount previously discussed) and the fund will be ready for the next emergency.
FINAL THOUGHTS ON AN EMERGENCY FUND
Great work on completing this critical step. Keep up the drive, and the focus on developing Mêtis. An established Emergency Fund will better equip you to handle unexpected events. Rather than simply surviving the financial jungle, you will thrive in it! To check out the next part of the series, click here.
Here are a few more posts that might interest you:
- Practical Guide & FAQ to the Health Savings Account (HSA)
- Saving for Retirement
- Indexed Universal Life Insurance Policies: Are They Good or Bad?
- Leaving an Inheritance for Your Children
THANK YOU FOR STOPPING BY
Thanks for checking out Mêtis Money Matters! We certainly appreciate it. If you’re new to our blog, or for more information on how you can start your financial journey today, be sure to check out our “Getting Started” Series.
To stay current on new material, please consider subscribing, today.
Also, please check us out on social media as we continue to grow and develop more content.
Feel free to leave us a comment or question. We would love to hear from you – let’s keep the conversation going in the comments, below!