The last few weeks have been unpredictable. It seems like things are changing daily. Businesses are temporary closing, employees are out of work, and supplies are in demand.
These unpredictable events due to COVID19 have escalated quickly, and are affecting the entire world.
This is a huge problem because everyone, at some point, has to deal with the unpredictable expenses of some kind. An emergency cash fund is one of the best tools in your financial arsenal to hedge against these personal black swans.
That way, if your home needs an emergency repair…
if your car breaks down…
or if you need cash to pay down a medical bill…
or if you suddenly find yourself out of work…
you have a buffer to help you through lean times (and avoid the downward spiral of having to take on debt).
Here is what everyone should know about building and maintaining an emergency fund.
Peace of Mind for Unpredictable Events
An emergency fund could be easily called a piece of mind fund, because of the calming effect having cash on hand has when the unpredictable occurs.
Its a cash cushion you can rely on when you are faced with uncertainty. Even having as little as $500 stashed away will help improve your outlook when life throws you a curveball.
You might even find that once you have some money saved for unpredictable events, you'll have trouble spending it unless an actual emergency occurs. It's a strange phenomenon that many experiences once that have cash savings in place.
A job loss can be crippling to an individual and a family if not prepared. It's an emotional event, a significant change, even a blow to one's ego. Having not to worry about immediate income through a transition like this makes all the difference. That's what an emergency fund does for you.
When you have savings, you can focus on finding a new job, repairing what broke, or caring for a sick family member. There's no need to panic because your money is covered.
How Big Should My Emergency Fund Be?
Your emergency fund should be able to cover six months of living expenses. This money is for the essential expenses only. You shouldn't calculate the size of this fund according to what money you bring home, but according to how big your critical expenses are.
So, take predictable monthly expenses such as your mortgage or rent, your food costs, any recurring healthcare costs, utilities and bills, transportation costs, and debt obligations. Add those up, then multiply by six. That's how much cash you should have on hand for emergencies.
This isn't one of those “the bigger, the better” cases. An emergency fund must be immediately accessible, so you can't tie this money up in investments. Therefore, there is a certain opportunity cost to every dollar that goes into this fund — every dollar set aside for unpredictable emergencies is a dollar that you cannot invest.
That's why the six-month rule is a good one to live by. Any less, and you risk not having enough to get through lean times. Any cash beyond six months of living expenses should go toward paying off debts if you have any, or investment opportunities.
That said, there are certain circumstances in which you can be flexible with the size of your emergency fund:
If you have a good safety net of friends and family, and you only have your mouth to feed and carry no large debts, three months of expenses could be enough for you.
If you're bringing home inconsistent pay (say you're working as a freelancer, or you're switching jobs and cities often), consider saving nine months to one year of expenses in your fund.
Where Do I Find the Money for an Emergency Fund?
Saving money for emergencies is nearly impossible if you carry large debts or are undisciplined in your spending. So, if you haven't done so already, your first step is to pull together a smart budget so you can track your spending and make necessary changes.
Each month, set aside a little money from your income to put into your emergency fund, even if it's just $20 in those first months. As you find ways to save more and more each month, you can then divert those savings into emergency funds and retirement accounts.
“Ideally, you should treat your emergency fund like any other recurring bill that you must pay each month,” Investopedia says. “Dedicate the appropriate amount from your paycheck and set it aside. While most people have no qualms about regularly sending enormous amounts of money to credit card companies, they balk at the idea of paying themselves first. Change that equation; cut up your credit cards and put those payments into your emergency fund.”
Where Should I Keep My Emergency Cash?
In an ideal world, you wouldn't ever have to touch your emergency cash. But when unpredictable events, like a pandemic, occurs, you need that cash, and you want to be able to get to it quickly and easily. Dave Ramsey recommends putting this money into a checking account, a savings account, or a money market account.
Avoid the temptation to try to “make this money work for you,” i.e., invest it. Will you earn money month-to-month off of this fund? No. But realize that you are nonetheless investing in yourself by creating an emergency fund.
“Some of us feel safer with a pile of cash on hand for when life happens,” Ramsey says. “Others don't want money just to sit there. They want to do something with it — like invest. Remember, though, the emergency fund is doing something. It's giving you peace of mind. You sleep better at night when you have cash saved. That is a great investment return on your money!”
What if you don't have an emergency fund and life punches you in the face? It's a scenario that's played out for many of us over the last few weeks.
First, take a deep breath; you don't want to make a big decision when you're stressed or upset. Once you've over the initial shock, begin to build a plan. Here are some steps you can take.
- Review your finance and cut out any non-essential items. (Prioritize food, shelter, utilities)
- Look for quick at temporary ways to make money.
- Leverage your skills and or current opportunities to earn money. (There's a big need for delivery drivers right now)
- If you can make a payment, communicate it. (There are several programs currently in place to assist those in need)
- Sell things you own to bring in cash.
- Stay calm and work at it every day.
- Ask for help.
Depending on your situation, you may need to be more aggressive with these steps. Also, don't be afraid to ask for help. Leverage your family and friends in a time of need.
Final Thoughts on Emergency Funds
The bottom line: You don't want to be among the 69 percent of Americans who aren't able to afford a $1,000 home repair without having to borrow money. Start building your emergency fund as soon as possible, with as much as you can afford to save every month.
As with any form of insurance, you're not going to need it until you need it. When that day inevitably arrives, you'll be glad you took action in advance and began to save.
Brian is a dad, husband, and an IT professional by trade. A Personal Finance Blogger since 2013 who, with his family, has successfully paid off over $100K worth of consumer debt. I want my three children to handle money better than I ever did at a young age. I have been teaching them as much as I can for the last 10 years. My goal is to continue to champion the financial literacy message and then why I created the “How To Rock Your Money” book. To help teenagers navigate their financial futures. I hope my family’s story of paying off over $100,000 worth of debt will inspire and motivate you to take control of your money. He blogs at BrianBrandow.com