Do you have an emergency fund? If not, you need to get one. Otherwise it’s only a matter of time before you'll wish you had been more prepared. One of life’s little surprises will come along and you won’t be ready.
When an emergency hits, the last thing you should do is reach for your credit card. More debt will only exacerbate the situation. You need to prepare for the unexpected. Financial emergencies come in all shapes and sizes, such as a job loss, medical expenses, or a home or auto repair.
An emergency fund is money set aside to pay for things other than your budgeted living expenses. In order to distinguish between budgeted living expenses and everything else, you need to have a budget. If you need help establishing a budget, check out our article entitled How to Create a Budget.
The first step in setting up an emergency fund is to establish is the amount of money required. Financial planners advise you to set aside three to six months of living expenses. If you own a home, you need money for repairs. According to MONEY Magazine, you need 1-3% of your home’s value set aside for home repairs.
The size of your emergency fund also depends on your situation. If you are part of a dual-income household, you may not need as much. What are the chances that both of you are going to lose your jobs at the same time? The fact that your spouse or partner works means you can probably get by for a month or two on just one salary.
Another deciding factor is the degree to which you are employable. That is a function of your profession and the economy. Fields such as nursing, engineering, and software development are always in demand. People in those fields don’t need six months of living expenses because it's unlikely they would ever be unemployed that long.
The next step is to determine where to keep your emergency fund. You can open a separate bank account or you can maintain the fund within an existing account. If you choose to keep your emergency fund in an existing account, you will need to treat it like an imaginary account within the existing account in order to keep track of it.
Once a month do a look-ahead to determine how much money you need based on your budget and spending habits. Any money left over is earmarked as part of the emergency fund. If you prefer to use an actual account, at the end of each month you would transfer excess funds into the account. Most banks allow you to do that online.
An emergency fund is only as good as the money that’s in it. Don’t let everyone know that you have an emergency fund or you may become the de facto emergency fund for your entire family. That sounds like a one-way ticket to the poorhouse. If you start lending the money in your emergency fund, you may never see it again. Anyone who can’t afford an emergency fund probably can’t afford to pay you back.
An emergency fund can give you peace of mind and prevent you from becoming a nuisance to your friends and family. Live beneath your means and set aside some money each month for a rainy day.Photo credit: Pixabay