What is an emergency fund?
An emergency fund is an account used to save money for emergencies.
What isn't an emergency fund?
It is not your credit cards, personal loans, home equity lines of credit, your retirement plan, or your possessions.
What is an emergency?
The term emergency does not necessarily mean disaster or medical emergency in this situation. This could be money to use when your car battery is dead and you need to buy a new one. This could be money to pay the deductible if your house is damaged in a storm. This could be money to live off of should you lose your job or become injured. This money could pay for unexpected medical bills.
Why do I need an emergency fund?
So you don't end up in debt. Also, so you have a safety net should something happen to you. Here's a personal story about why I love having an emergency fund. Last month our air conditioner stopped working right. We figured it was just a minor problem. The repair people came out and found that our compressor had died. As it turned out federal regulations had changed and in order to repair our air conditioner they would need to put a brand new one in. It was going to cost a lot of money. We thankfully had enough money in our emergency fund to cover it. We didn't have to worry how we were going to pay for it, if we could pay for it, what would we have to do without, etc. It was such a relief. I can also attest to not having an emergency fund and being afraid that something would go wrong. Having been on both sides, it's much better to not have to worry about it.
How much money do I need in an emergency fund?
Well the financial advice varies on that one. I've seen anywhere from 3 months to a year. It also varies between your take home income and your expenses. I personally would do at least 8 months of expenses, but ideally a years worth would be the best. A lot of guidelines base it off of if you lost work. It used to be that it would take about 3 months to find work again, but as we know that isn't always the case. So the correct amount for you is all about your comfort level, and how much you would be willing to give up if you lost your source of income. Use your budget as a guide to figure out an amount for you.
Where will I find money for an emergency fund?
The same place you find money for anything else! If you were in debt and paid it off, then that's an easy place to look for money. Take those payments and put them to your emergency fund. Ideally you are already budgeting money for savings. You can find money in all sorts of places if you make it a priority.
What should I do with the money?
I'm not a financial planner so I can't tell you what to do, but I can give you ideas. Don't put it in your mattress or anything like that (although it is a good idea to have cash on hand...), put it someplace it can make some interest. However, don't put it someplace that isn't liquid. By that I mean don't stick it into your 401k or CD's or stocks. You need it to be in something that you can access at any moment without penalty. A good option is a savings account or a money market account. Check with your bank or a financial planner for more options.
Can I use the money in my account for other things?
It's your money, I can't tell you what to do with it. What I can tell you though is if you use your emergency fund to pay for a vacation, and then you have an emergency you probably will wish you didn't go on a vacation. Think in terms of how long it will take to regain all the money you use, and never deplete the whole account on something other than an emergency.
What do I do once I have my emergency fund?
Whatever you want to do with your money, some suggestions are funding your retirement to the max, saving for a down payment on a house, saving for a child's college education, investing, or saving for a major purchase. It all depends on what your personal priorities are.
Join me next week for more on emergency funds.
