What would you do if you were in a car accident, or if the roof on your house suddenly needed to be repaired due to a bad storm, or your washing machine needed to be replaced? Where would you find the money? If your answer is, “I don’t know”, then you’re in the right place. The solution you need is an emergency fund.
What is an Emergency Fund?
An emergency fund is money you have set aside in case of an emergency, such as job loss, car accident, unexpected medical expenses or major house repairs. Having a fully funded emergency fund gives you an amazing sense of security – you know everything will be okay financially, so you don’t need to panic.
Your emergency fund will cover your fixed expenses, such as
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- Mortgage or rent payments;
- Car payments and maintenance;
- House, car or appliance repairs;
- House expenses, including heating, electricity, water, etc.; and
- Groceries.
So, when something unexpected happens, you can use your savings instead of having to rely on credit card debt or personal loans. Let me repeat that point – your credit card and loans are NOT your emergency fund. Why? Simple – if you don’t pay your credit card in full, you have to pay interest on the outstanding balance. Paying interest on loans (other than mortgages) is a sign of bad financial health.
How Much Do I Need to Have in My Emergency Fund?
If you have too little in your emergency fund, then you risk having to take on debt – along with all the interest that debt will incur. However, if you have too much, you face an opportunity cost because that money could have been invested instead – and used to make you money. So, how much should you have in your emergency fund? Here are some guidelines.
How Many Months Should My Emergency Fund Cover?
Financial experts recommend having between 3 – 6 months of fixed expenses in your emergency fund. This time period allows you to find another job or recover from an illness. In this step, you will decide how many months your emergency fund will last – 3, 4, 5 or 6 months. As a general guideline, the more stable your household is, the less you will need (ie: three months will be sufficient). Read below to see where you land in the three-to-six-month range.
Three Months:
* You are in a two-income household – the rationale here is that as long as one person is working, there will still be some money coming in; OR
* There is a high demand for workers in your field, so you can find another job rather quickly; OR
* You can easily move in with relatives and significantly reduce your expenses.
Six Months:
* One income household; OR
* Self-employed or earnings are based only on commissions; OR
* Someone in your household has a chronic medical condition, which may result in large medical bills or time off work.
SUMMARY – ACTION STEP #1: Use the guidelines above to determine how many months you will need your emergency fund to last.
How Much Money Should I Have Saved per Month?
Now, comes the fun part – actually calculating how much money you need each month! Okay, so maybe I’m the only one who thinks that crunching numbers is fun, but it does need to be done. At a minimum, you need to cover your fixed costs (that were mentioned above, like rent/mortgage, housing costs, food, etc.), as you can temporarily cut out variable costs. Variable expenses include things like eating out, general shopping and gifts – basically all “wants”. If you want to keep the same lifestyle, then include both your fixed and variable expenses.
If you’re not already tracking your spending, now is the time to start. Go back through the last three months of spending and add up all of your expenses. Take that number and multiply it by the number of months you want your emergency fund to last – and voila! That’s the size your emergency fund should be.
SUMMARY – ACTION STEP #2: Track your spending for the last three months. Take the average amount you spend in a month and multiply it by 3-6 (as determined in action step #1). That’s how much your emergency fund needs to be. For example, if you need $3,000/month to cover all of your expenses for 3 months, then your emergency fund should be $9,000. However, if you need $3,000/month to cover all of your expenses for 6 months, then your emergency fund should be $18,000.
Where Do I Keep my Emergency Fund?
As an accountant, I recommend keeping your emergency fund in a separate account. That way, you won’t be tempted to use the money for other things. It also allows you to easily see the balance of the account and how close you are to your goal. Keep in mind that whatever account you have the money in, it needs to be easy – and quick – to access.
Your best bet is to open a high interest savings account. Yes, they do exist, even if the interest rates aren’t as high as they used to be in the past. The benefit of these accounts is that any money there will earn some money on it, as opposed to none in a typical chequing account.
Now, before you rush out and open your high interest savings account, there are a few factors that you need to look into. Most importantly, you want to be aware of the fees and conditions attached to the account. Be sure to ask if there is a:
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- Minimum deposit required,
- Minimum balance required, and
- Other fees to be aware of.
Finally, you will also want to consider convenience when making your decision. Online banks may offer higher interest rates than a typical bank, but you need to consider service. How easy will it be to transfer your money from the emergency fund account to your regular bank account? If you open a new account with your existing financial solution, the two accounts will be linked together online. This link will make it easy to transfer money from one account to the other. After all, in an emergency, you will probably need to access that money quickly!
When Do I Use My Emergency Fund?
Expenses can come up that are unexpected. But is it an emergency or not? Here are three questions to ask yourself before you use up that emergency fund:
1)Is this expense unexpected? Certain expenses can be expected, especially if they occur once every three months or once a year. These items should be part of your budget, so that you have the money saved for when they do happen.
2)Is this expense necessary? Do you really need to spend the money or can you do without that item – even just temporarily?
3)Is this expense urgent? Yes, you might want to fix or replace your car right away, but maybe it can wait for a few months while you save up the money. Think of alternate solutions – like taking public transit or sharing the car with your spouse.
If you answer yes to these questions, it’s probably an emergency and it’s okay to go ahead and use your emergency fund.
Get Your Emergency Fund Started Today
Take a moment to think about how it will feel to have your emergency fund fully established. When an unexpected expense happens – when, not if – you’ll be prepared. No more stressing about how you’re going to pay the bill when it comes in – the money is already saved, just for this purpose. When you have an emergency fund, you can breathe easily. Set aside some time, a half hour every week, and go through the steps above.
You’ll also like:
* How to Live Below Your Means and Still Enjoy Life
* 9 Common Limiting Money Beliefs (And How to Transform Each One)
* 10 Simple Money Management Tips
Until my next blog post, here’s wishing you lots of joy and happiness!
With love,
