What Is an Emergency Fund and Why You Need It

personal finance Sep 04, 2020
Personal Finance, Investing, Saving, Emergency Fund by TTM Education

According to Vanguard, “an emergency fund is a stash of money set aside to cover the financial surprises life throws your way.”

Everyone needs an emergency fund whether they think they do or not. No one can predict the future. You don’t know if your car will break down tomorrow, if an unexpected medical emergency occurs, or if you’ll need to replace your water heater.

If you live pay-check to pay-check, you don’t have the extra funds to fund an emergency. That could leave you in a dire financial and personal situation or put you into serious credit card debt.

That’s why an emergency fund is important. If you’re not sure where to start, read on.

1. Figure out your expenses.

An emergency fund has 3 to 6 months of expenses in it. This includes all fixed and variable expenses, such as your mortgage, car payment, insurance, food, utilities, and gas (just as examples). 

Pull your bank statements for the last few months to see your total monthly expenses. Multiply that number by 3 or ideally 6 and that’s how much you need to save.

2. Start small and save $1,000.

Don’t freak out at the number you just calculated, it’s likely a big number. Break it down into manageable goals. A good starting point is $1,000. You can fund many small emergencies with $1,000. Small car repairs, minor home issues, or even unexpected medical bills often fall under $1,000.

Find small areas you can save and sock away the money. For example, if you clip coupons and save $100 on a purchase – put that $100 away in your savings account. If you knock down a few bills by shopping around or negotiating, put the difference in your savings account.

3. Work your way up to a fully funded emergency fund.

After you achieve the $1,000 threshold, work your way up to saving at least 3 months of expenses. 

If your expenses are $2,000 a month, that means $6,000. If that’s too much, look at your regular expenses and see where you can cut. Do you spend needlessly? Cut things like unnecessary (or unaffordable) memberships, expensive cell phone or internet bills, or high credit card APRS.

Shop around for the best deals too. New customers often get better deals on internet and cell phone bills than loyal customers (it’s a marketing thing). Look around for cheaper insurance or find other areas to cut your spending and increase your savings.

4. Invest your funds.

The final step is to invest your funds. You don’t want your emergency fund to be accessible – that’s too tempting. Instead, put it away somewhere you can’t easily access it. A few good places include:

  • Online high-yield savings account
  • Robo-advisor that invests in ETFs
  • CDs
  • Money market account

Don’t Go Without an Emergency Fund

If you can’t answer how you’d fund an emergency, you need an emergency fund. Start your goals small and work your way up. Eventually, you should have enough to live off of for 6 months or longer. If you lose your job, get hurt, or suffer a major financial emergency, you’ll feel better knowing you can fund it easily and not put yourself under more financial stress.

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