Whenever we sit down to draw out our financial plan, it’s impossible to predict the emergencies that might arise. Even if if we tried to guess what emergencies may come, they wouldn’t cooperate with our plan anyway.
So how can you plan for something when you don’t even know what it is? The answer is to have an emergency fund.
What is an Emergency Fund?
An emergency fund (or a rainy day fund) is a pile of money that you have prepared for those big emergencies. It keeps you and your finances protected when the unexpected happens. Without some sort of financial buffer, your emergencies become a lot bigger.
Your rainy day fund is like wearing your seat belt in your car. You put it on just in case there’s an accident. Most of the time you’ll get from point A to point B without any problem, but when an accident does happen, you’re glad you had it on.
Why Do I Need One?
Having that financial seatbelt ensures a bad day doesn’t become devastating. Losing your job is bad enough; not knowing how you’ll pay the mortgage adds a whole new level of stress to the situation.
When you have a cash reserve, you are better equipped to face those curveballs life throws at us. If your air conditioner goes out, the financial stress is taken out of the situation. You have the money stashed away for this exact reason. Simply call a repair man and fix it.
Where Do I Keep an Emergency Fund?
You want your emergency fund to be easily accessible. That way if something comes up you can get to it quickly. However, be sure it’s not too easy to get to.
You don’t want your rainy day fund sitting in your checking account. It would be too tempting to spend it on things that don’t count as an emergency. I recommend opening a savings account at a separate bank or credit union from where you have you currently have your checking or savings accounts. This keeps the money safe and accessible, but prevents you from hopping on your phone and transferring funds when you’re tempted to spend it.
What Counts as an Emergency?
Plain and simple; an emergency is something that you didn’t know was going to happen, so you were unable to plan for it. This includes car accidents, medical emergencies, a death in the family, losing your job, or one of many possible scenarios that could occur. If it’s something you couldn’t financially prepare for, it’s an emergency.
There are a lot of things we think are emergencies, but they’re actually not. Needing to replace the tires on your car wouldn’t count as an emergency. We know that our car is going to need new tires as some point. It’s not an unexpected expense, so it’s something we can plan and save for ahead of time.
The same thing goes for birthdays and holidays. Needing to put presents under the tree isn’t an emergency. Try using a sinking fund to save throughout the year so that Christmas doesn’t sneak up on you!
How Much Should I Have in My Emergency Fund?
If we can’t predict an emergency, how do we know how much money we’ll need? Good question.
I always recommend having an emergency fund that equals about 15%-20% of your annual income. If you make $100,000 a year, then you should have between $15,000 and $20,000 put away in a savings account for when you need it.
Another rule of thumb is to have enough to cover 3-6 months of your living expenses. Look at your budget and calculate how much you need to survive each month. This means just enough money to pay for rent, utilities, transportation, and food for your family. Don’t include the cost of cable, restaurants, or fun money in this number. If your house needs $2,000 each month to survive, then it’s a good idea to have between $6,000 and $12,000 set aside.
Having this much will protect you from most of life’s unfortunate events. What if you lost your job and it took you 3 months to find a new one? Having this financial buffer will ensure your family is fed while you look for your next career opportunity.
Are you protected from life’s emergencies? If you’re stuck living paycheck to paycheck, you may be one bad day away from a financial train wreck. It’s incredibly important that you protect your family and your finances by building a rainy day fund as soon as possible. I can help you take the necessary steps to financial freedom. Email me at firstname.lastname@example.org to set up a free consultation.