When it comes to financial planning, one of the most important things you can do to ensure your financial security is build up an emergency fund. An emergency fund is money that you set aside to cover unexpected expenses, such as a job loss, a medical emergency, or a major car repair. While it probably doesn't come as a shock to learn that having emergency cash on hand is a positive thing, many people fail to grasp just how crucial it is to plan for the unexpected. Having an emergency fund gives you a cushion to fall back on if tough times arise, and it can help you avoid going into debt or tapping into other financial resources, like your retirement account.
So, how much should you have in your emergency fund? Experts have typically recommended having three to six months' worth of living expenses set aside for an emergency. However, given the unprecedented economic upheaval caused by the COVID-19 pandemic, many are now recommending that individuals have at least six months' worth. This might seem like a lot, but it's important to have enough money to cover your basic needs if you suddenly find yourself unemployed or facing a major life crisis.
Of course, how much you actually need to save will depend on your individual circumstances. If you have a steady income and few major expenses, you may be able to get by with a smaller emergency fund. For example, if you have no debt and your only monthly expenses are rent and utilities, you could probably get by with just a few thousand dollars set aside. On the other hand, if you have a variable income or high monthly expenses — think significant credit card debt, a mortgage, or some other major monthly expense — you'll need an emergency fund that accounts for them. The size of your emergency fund also depends on you and your comfort level. If you're comfortable with a higher level of risk, you may be able to get by with a smaller emergency fund. But if you want to be prepared for anything, it's best to err on the side of caution.
Now that we're all on the same page regarding the importance of having an emergency fund, how can you build one or bulk up an existing one? Here are a few simple steps.
- Set a goal amount. As we mentioned above, the precise amount you will want to keep in your emergency fund will be unique to you. However, we recommend aiming to save six months' worth of basic living expenses. To determine this amount, take a close look at your monthly expenses, including rent or mortgage payments, car payments, credit card payments, and other bills. Once you have your monthly total, multiply it by six.
- Make a saving plan. Odds are you don't have six months of living expenses lying around, and you'll need to plan to reach your goal. Whether you choose to put a set dollar amount toward your emergency fund each month or cipher a percentage of each paycheck into a separate savings account, every little bit adds up. Don't be discouraged if your fund doesn't come together overnight. Building up an emergency fund takes time and discipline, but it's well worth the effort.
- Keep the funds in a safe but accessible place. Deciding where to keep your emergency fund is another factor to carefully consider. On the one hand, you don't want it to be so readily available that you're tempted to dip into it for everyday expenses. On the other, you don't want it to be so inaccessible that you can't get to it when you need it. The ideal savings account is separate from your checking account so you're not as tempted to spend it and it has a good interest rate so your money can grow while it's safely tucked away.
The bottom line is that an emergency fund is an essential part of financial planning. As your financial advisor, I seek to empower you to achieve success on your own terms and enable you to feel self-assured about your ability to thrive financially. I believe that an emergency fund is an important piece of your financial puzzle, regardless of the stage of life you're in. By taking the time to build up this fund, you can protect yourself from financial hardship and rest assured knowing that you're prepared for whatever life throws your way.
If you would like to discuss the role your emergency fund plays in your overall financial picture, please don't hesitate to get in touch!