Before discussing what an emergency fund is and why you need one, let’s look at some interesting info.
The Federal Reserve published “Report on the Economic Well-Being of U.S. Households in 2017” and it contained these facts.
- 4 in 10 adults would not be able to come up with $400 to cover an unexpected expense without selling something or borrowing money.
- Over one-fifth of adults are not able to pay all of their monthly bills in full.
- More than 1 in 4 adults skip necessary medical care because they could not afford the costs.
Source: Report on the Economic Well-Being of U.S. Households in 2017: (Page 10)
Here’s another alarming fact: as of May 2018, the average length of unemployment is 22 weeks. That’s 5.5 months! Think about it. Could you afford to be out of work for 5 months? And just think, this is a vast improvement from August 2011 when the average was 40 weeks. Keep in mind, since these are only averages, for some people these figures are much higher, even doubled! Life is unpredictable and anything can happen at any moment; that’s why an emergency fund is so important to have.
An emergency fund is money that you keep tucked away in case of, you guessed it, an emergency. Some things that could be considered emergencies are
- Car repairs (ex: breakdown, popped tire, accident)
- Unemployment and inability to pay bills
- Unexpected medical expenses for yourself or a loved one
- Home repairs (ex: pipes burst, burglary, refrigerator stops working)
If you want to maintain a real emergency fund it is important to understand what counts for an emergency and what does not. Here are some examples of things that are NOT emergency expenses:
- A new 4K Curved TV (although it is as nice as it is tempting!)
- A vacation in the Bahamas
- A new leather couch
All of the above are awesome to have, but don’t dip into your emergency fund to finance them. If you have the extra money, then great! Life is worth enjoying and you should splurge on some luxuries for yourself. However, if you do not have extra money to pay for these luxury items and trips, focus on building your emergency fund first.
Things happen in life. It’s best to be prepared. It sucks when you have to sell your personal belongings or have to ask someone for money. This is why an emergency fund is necessary. Now, how much does your emergency fund need? Well, that all depends on your expenses. Generally, NoDegree recommends that you should save enough to cover 7 months’ worth of necessary expenses. Why 7 months? Since the average length of unemployment is about 5 months, it is important to have a cushion that goes beyond that time so you are not overly stressed if you do happen to lose your job. If you are living paycheck to paycheck, when you lose your job you will be living a literal nightmare: selling your stuff, borrowing money, constantly running out of money, and sinking further into debt. However, if you lose your job and have at least 7 months of expenses covered, you won’t be nearly as stressed and you’ll be able to focus all your energy on finding a new job.
Another important thing to consider is that if you do not have a lot of savings, you are forced to take the first job that comes your way, whether or not it hits your salary target, just so you can put food on the table. If you could afford to wait a little longer, a job that hits or exceeds your salary target could land right in your lap. Being able to wait an extra few weeks can make a difference of 10-20% in your salary! Also, it is best to be able to compare job offers when searching for jobs to help you figure out how much you are truly worth to companies.
One of the most important things in life is your health. You should never have to be in a situation where you must put your health second just because you do not have the money to treat yourself or get yourself checked out. All you are doing is causing bigger problems down the road. A simple treatment or examination performed within a timely manner – as opposed to waiting weeks, or months to see a doctor – could prevent more serious, and more expensive, conditions that could drastically change your life in the future.
So, how do you start an emergency fund? One of the best ways to start saving is to set up an automatic transfer from your bank account or paycheck. This way, you are used to a smaller paycheck and are used to budgeting with less money. NoDegree also suggests that you keep your emergency fund in a different account, or bank, from your regular checking account. If you keep your emergency fund separate from your regular account, you will be psychologically separating your emergency expenses from your regular expenses. Think of this set up as keeping your emergency money, “out of sight, out of mind,” leaving you less likely to withdraw from it when you don’t really need to. Even if you save a few dollars a paycheck, it is better than nothing. Once you get into the habit of saving, you can really try to test out how much you can save in a month. Life will be a lot less stressful once you build up a decent emergency fund!
