According to a report by Bankrate 66 million Americans haver zero saved for emergency expenses. You might think low-income households face the most difficulty creating a financial cushion, the problem is hardly confined to the poor. More than half of all households with an annual income under $30,000 have no emergency savings. But one in six households with an annual income between $50,000 and $75,000 had no emergency savings either. In general Americans are in need of understanding the importance of an emergency fund.
An emergency fund is for an emergency ironically enough. Now first thing we must understand is what is considered an emergency. Is buying that new outfit and emergency? Or how about going out to eat? The answer to both of those questions is a very solid NO. An emergency is best described in my opinion as something that is a need in your life and you can’t cover the expense. A blown tire on your car, or an electric bill, and even an unexpected medical expense. So, when we talk of an emergency we must understand fully the difference between a need and a want.
I often get asked “How much money should I have in my emergency fund?”. There is no exact answer to this question. It really depends on the person’s situation. Yet a great rule of thumb is 3-6 months’ worth of living expense to cover all your needs to survive. Yet If you feel better with 12 months’ worth of expenses I would go with that. How much do you feel you need to sleep well at night?
Next, we must figure out where to stash the money for our emergency fund. There are tons of choices which can make it very hard for someone to choose. Some are very risky, other are very secure. For this I would start with just using a regular savings account, money market account or a few CD’s. Of course, you will not make a great return on this money in the above vehicles yet that is not the point here. The point is to have fast access to cash for when the worst happens. It is better to play it safe with your emergency fund than to invest it at a greater risk of losing some of the cash. Are you willing to lose some of your money for a chance at a return?
Imagine that you decided to invest your $5,000 emergency fund in the stock market. Three months goes by and you are now at a loss of $1,000 and your car breaks down. The bill to fix your car is $2,500. No sweat, because you still have $1,500 left in the account after those two setbacks. Yet Murphy strikes again and your dog needs to go to the vet and after everything is said and done the vet bill was $2,000. This is why you should keep an emergency fund in a very secure account where there is no risk.
An emergency fund is a very solid piece of being financially secure in life. The easiest way to build one is a little at a time. If you can only afford $50 a month that is better than saving nothing a month. Eventually you will build the emergency fund you desire that will be there in case the worst happens. At the end of the day an emergency fund gives you piece of mind. Be on the lookout for a more advanced stage emergency fund post.
What are your thoughts on emergency funds?