Why you need an emergency fund
Emergencies usually happen when we least expect them – that’s just how life is. And if they happen when you’re not prepared, they can wreak havoc on your finances. That is where the importance of emergency fund in your budget comes in. An emergency fund can act as a safety net and reduce financial stress in an emergency. To help you out, in this article, we’ll talk about the importance of having an emergency fund in your budget and how to build it.
What is an emergency fund?
We’ve all experienced some kind of costly emergency. From your car breaking down to your home being flooded, these things can cost a lot of money.
The emergency fund is a cash reserve for unplanned expenses or financial emergencies. As all budget coaches will tell you, not having an emergency fund is one of the worst budgeting mistakes. It’s important to have a safety net when emergencies happen. You can use your emergency funds to pay all unanticipated bills, deductibles that insurances don’t cover or payments that are not part of your regular monthly budget expenditures and spending.
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It’s important
For starters emergency funds can cover many of the unexpected expenses. Paying with the money from your emergency fund means you won’t have to depend on credit cards or loans. Whether it’s a medical bill, vehicle repair, or home maintenance, you will be paying it all off with available funds. This will also help you avoid possible debt and expensive interest rates.
Moreover, without an emergency fund these unforeseen circumstances can cause a drastic alteration to your way of living. After a single incident, you might have to liquidate your assets simply to pay for the emergency. For example, if you lose your job suddenly, you might have to take a financial hit or sell some of your belongings to pay for all your expenses. On the other hand, with an emergency fund, you will have a longer window with your current budget, to work out alternative arrangements, cut back on your spending, or find another job.
How much should you have in an emergency fund?
Now that we’ve covered the importance of an emergency fund, let’s get into more concrete discussions about them. Many people have trouble calculating how much money they need to save. Generally speaking, the amount you need in an emergency fund is determined by several variables, including your monthly expenses, salary stability, and the probability of having an unexpected event.
As a general guideline, you want to aim for 3 to 6 months of emergency savings. In case of a job loss or other unforeseen circumstances, this amount will initially cover your essential costs, like rent or mortgage, electricity, food, and transportation.
Be ready to adapt
Depending on your unique situation, you may require more or less than 3-6 months’ worth of expenditures in your emergency budget. For instance, you might feel at ease with a smaller emergency budget if you have a steady job or live in a dual-income family. On the other hand, if you’re self-employed, do not have a steady income, or others depend on you to provide for them you it will be more important to strive for a higher balance in your emergency fund.
Periodically review
Your financial position might alter over time, so reviewing your emergency funds and making necessary periodic adjustments is crucial. For instance, if you have a new infant or purchase a new house you will want to increase your emergency budget to account for these new costs.
However, you may not have to dip into your emergency funds. Instead, you could plan an entirely new budget designated explicitly for that thing. So, if you’re buying a new home, you’ll need to plan your move and set a budget from the start. Similarly, when you realize you’re expecting, you take time to figure out the budget for everything baby-related. That includes buying clothes, diapers, furnishing a nursery, childcare etc.
How to build an emergency fund
To start building your emergency fund, first establish your monthly budget. Pull out your pen and paper or Excel spreadsheet and calculate all your expenses. That includes your mortgage or rent, electricity, meals, travel, and any other necessary costs you and your family face, as well as those discretionary expenses that always manage to be part of a busy lifestyle.
Then, set a savings goal for your emergency fund based on this amount. Don’t be afraid to shoot high to ensure you’ll always have enough money. As mentioned earlier, aim for at least three to six months’ expenditures based on your current situation.
After this step it’s time for more concrete moves. Find places to reduce spending, such as on subscription services or dining out, and put that money toward your emergency budget. If you find this hard to do on your own, a budget coach will help you set your financial goals and plan how to achieve them.
Finally, it’s crucial to refrain from pulling money from your emergency fund for things that aren’t emergencies. It may not sound like it is, but this is the most challenging part of saving money. No matter how tempting it is, only use your emergency fund in genuine emergencies and keep it distinct from your regular checking and savings accounts. It will be tough to keep at this initially, but hopefully, you’ll get better at it with time.
Final thoughts
The importance of an emergency fund can’t be overstated. This fund is an essential part of financial planning. Remember that building an emergency fund requires time and work, but it is worth it. Even if you can only save a small amount each month, it all adds up over time. And while you can’t predict the future, you can take steps to prepare for it and gain a greater sense of security in the process..
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