Having an emergency fund is essential to sound money management. It can provide much-needed calm and help you cope when something unexpected occurs.
Not having enough money to pay for an unexpected bill can be very stressful. Worse still is when someone to whom you owe money contacts you and asks you directly for payment. Just thinking about that scenario makes me squirm.
While I like to think of myself as being well organized financially, I get caught short a couple of times each year. This year alone, my dog needed dental surgery, my husband needed medical care, and our car needed an unexpected repair. I’d budgeted for these scenarios and had been setting money aside, but the final amounts owing were more than I had anticipated.
A situation like this used to stress me out, so to prevent that, I made a plan, and that was to always have three to six months of monthly expenses set aside in an account called Emergency Fund.
Over the years, I’ve dipped into this fund several times a year to cope with an unanticipated financial emergency, whether it be a car repair, a dental bill, or lost earnings due to a global pandemic.
If you currently have consumer debt (like credit card debt or a car loan), then while you are paying that off, a rule of thumb is to keep an emergency fund of $1,000 to $2,000 as cash in the bank. This way, when something goes wrong, you can reach over and pay cash for it. This prevents you from going back into debt again, and you can keep the momentum going that had you getting out of debt.
When you have paid off your consumer debt (but you may still have a mortgage), building your emergency fund up to somewhere between three to six months of monthly expenses is a good guideline. I use my PocketSmith Income & Expense Statement to work out a monthly average and I set aside multiples of that.
Few people can simply just set aside thousands of dollars in one move. What is more likely is that you commit to building up an emergency fund over time. The first move is to open a bank account, call it Emergency Fund, and then start an automatic weekly payment into it. When cash allows, you can add lump sums to it until you reach your magic number. Then you can stop payments into this account and just leave it be.
It’s the hardest thing to start and build up, but once you have filled that bucket up, it’s done!
This is the familiar cry I hear about an emergency fund, that this money should be “put to work” or be invested somewhere to make money. But I say NO to this and encourage you to think about why you’re setting it up in the first place. It’s an insurance policy, a “Get Out of Jail Free” card, and it needs to be easily accessible so it can be deployed at a moment’s notice.
Suppose you don’t have an emergency fund, and you put an unexpected bill on credit. In that case, it’s going to have a ripple effect within your budget for the next week, month or year until you can pay both it down AND all of the other bills you have already committed to paying.
If this money is tied up in an investment and is hard to access (or you are reluctant to sell), you are more likely to put your financial crisis on a credit card instead, which will only exacerbate your problems. Think of an emergency fund as your personal insurance policy where you don’t have to fill out the paperwork to get to it!
As we each grow and mature, if we are handling our money well, over time, the amount of money that you will have set aside for an emergency fund will feel small, compared to the other investments and wealth that you create in other parts of your life.
Just like emergency exit doors on a plane aren’t used for regular disembarking, emergency funds should only be used for the unexpected financial event that falls outside of what you have planned and budgeted for.
However, the only person deciding on what constitutes a crisis will be you. And it is entirely within your control to solve your own financial emergency! You don’t need to ask your bank, nor ask for a cash advance on your wages, nor turn to a credit card, So, trust yourself to make the right decision. Creating an emergency fund is the ultimate test in self-control — and also self-respect, come to think of it.
After such a lot of work has gone into saving it up, there can be a mental block to actually using it in an emergency, but I encourage you to use it when appropriate and give yourself a pat on the back for having the foresight to set aside some income for such a purpose. When you dip into it, just set up another automatic payment to drip-feed money back into your emergency fund to top it back up to the full amount.
Having a fully-stocked emergency fund means I have set aside some income for “sometime later” for an unknown purpose. There have been countless times over the years when I’ve suffered bill shock, that jolt of “OH NO” when you receive an unexpected account. But I can assure you that each time this initial shock is replaced by a feeling of calm as I just reach over, access the money I’ve set aside and pay the invoice in full, put it behind me, and just get on with my day. Crisis OVER in an instant.
A rainy day fund tailored to your specific circumstance gives you breathing space. I’m sure that many more financial emergencies await us; that’s life. Still, the thought of one occurring does not raise my stress levels because by thinking ahead and systematically setting some money aside, I’ve prepared for them as best as I possibly can. When the inevitable happens, I won’t hesitate to break the seal on our emergency fund and reach in, take what I need, and end the crisis. It’s honestly such a gift.
Ruth blogs at thehappysaver.com all about how she and her family handle money. What’s the secret? Spend less than you earn, invest the difference, avoid debt and budget each dollar that flows through your hands. She firmly believes that if you can just get the basics right, life becomes easier from there on in.