What is an Emergency Fund?

Posted by Alan J. McMillan on Wed, Aug 05, 2015 @ 08:00 AM

emergency fundEvery major financial guru that I know recommends having an emergency fund, and for good reason. This MUST be part of your financial plans as you move forward. Modest, regular funding into an emergency fund will get you to where you need to be over time.

What Is An Emergency Fund?

  • An emergency fund is a separate back account that you build over time in order to build a buffer from unexpected financial emergencies that invariably happen
  • Best put, “it protects you from the storms of life and gives you peace of mind”

Do I Need One?

  • Yes

Why?

  • When life serves up financial surprises, you are prepared
  • If you don’t have one, and life delivers that surprise, you are susceptible to:
o   Reaching for high interest debt (ex:  Credit Cards)
o   Invading or borrowing from long term retirement assets (ex:  401k)

What Is An Emergency?

An major unexpected financial expense like:

  • Loss of a job
  • Medical expense
  • Major automobile repair

What Is NOT an Emergency?

  • A vacation
  • Gifts at the holidays
  • Payment of an annual or semi-annual bill
  • A big ticket item on sale

How Much Money Do I Need to Put In My Emergency Fund?

  • Most often, you are told 3-6 months of normal living expenses should go in your fund
  • Here is how you determine what YOU need:
o   If you were to lose your job this afternoon how long would it take you to find a job better than the one you just lost?
o   Fund that amount of time
o   Some experts recommend setting aside up to 24 months of living expenses

Is It Normal to Have One?

No, According to a Bankrate.com report

  • 26% of Americans have NO emergency savings
  • 67% have less than 6 months
  • 50% have less than 3 months
But yes, you need one...
  • Remember you are on the road to being exceptional
  • Normal or average is statistically disappointing
  • Most Americas are not smart with money and they end up wishing they had played money-smarter over the course of their career

Where Do I Put My Emergency Funds?

  • Separate account from your main bank account
  • Highly liquid (easy to get to with no penalties)
  • This is NOT an investment, rather, a security blanket

How Do I Get Started?

Begin to fund this slowly, but a small amount from every paycheck. Doing this with auto-deposit when you start with employer is the most effective way.

Do this simultaneously with

  • Funding your retirement accounts
  • Paying off student loans

It is estimated that some people will take 2-3 years to fully fund this, it is best to get started now.

Conclusion

Prior to building an emergency fund, it is suggested you are out of high interest short-term debt like credit cards.

Make this part of your regular budget. This allows you to say on-track when the unexpected happens. It also gives you more flexibility to be choosy during a job search because you don’t have a financial gun to you head. You have time, and time gives you the ability to hold out for a great role.

As in all things financial, the hard part is getting started.  It is better to build this slowly and consistently than to ‘wait until you have a big financial windfall.’

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