Everything you need to know about starting an emergency fund

If you read enough personal finance articles, you’re bound to come across somebody talking about an emergency fund. That’s because they are extremely important–everyone should have one. Emergency funds are a critical first step in being a fiscally responsible adult.

Let’s answer some questions you may have.

What is an emergency fund?

An amount of money you set aside for emergencies or unexpected expenses. Simple enough. Ideally, this is money that you never touch, is easily accessible, and can hold you over long enough to find your footing.

Why do I need one?

Because emergencies are a fact of life.  You never know when they’ll come or what kind of costs you’re going to be on the hook for. And it’s better to be safe than sorry. Your level of financial savvy is not dependant on how much you make, it’s dependant on how prepared you are.

Why should I have a separate emergency fund when I have money in my accounts?

If you invest your savings (into money market accounts, savings bonds, or any other vehicle) that money might not be available when you need it most. Also, any money you invest should be money you intend to grow over time. Take anything away from this would hurt your future possible returns.

How much money should I have in an emergency fund?

That depends on who you ask. One option is to go by your cost of living. The most conservative people will say enough money to last you 8 months or so, while the least conservative would be happy with a 3 month supply. Ideally, it should be within this range.

Another method is to go by your monthly salary, and just commit a portion of your savings until you have 3-6 months worth of salary saved up.

How do I know how much that is?

If you’re going off your cost of living, then the only way is to crunch the numbers. You’re going to have to sit down and calculate how much you spend, where you spend it, and how much of your income goes towards savings. This might seem tedious, but it’s also the best way to take stock of your personal finances.

Now what?

Now it’s time to build the fund. Your best bet for this is to take a little money from both your savings and expenses. Divert some of that paycheck to this fund every month, and cut back on a couple of expenses. Remember, this isn’t a permanent use of funds. Once you’ve reached the threshold you’ve decided on, you can set your emergency fund aside and forget about it until things change.

Why would I need to change it?

If your salary or living expenses change, you’ll need to adjust your emergency fund to match. This ensures that you stay prepared for emergencies over time.

When should I touch this money?

Almost never. This is not money to spend when you’re buying a car. This is not money to spend to fund part of a vacation. This is money for an absolute emergency that you did not foresee, like you getting laid off or having an unexpected medical expense.

 

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