If you don’t have an emergency fund, you need to start working towards this right now!
You’ll never hear me say this about anything else. Invest when you feel ready, buy real estate when you have the funds. However, creating an emergency fund is the opposite. You need an emergency fund now. Here’s why.
What is an emergency fund?
Life isn’t fair. Even with a meticulous budget, there will be unpredictable expenses in life. An emergency fund is a pool of money set aside to cover any unexpected financial costs that you may encounter. Some of these type of expenses that I have encountered in the last two years are:
- Hit and run on my car – $750 (My door had to be replaced)
- Psychologist appointments – $1k+ (After a portion was covered by Medicare)
- Dental costs – $5k+ (Ended up needing a crown and lots of fillings)
- Being made redundant and losing my job – $2k+ (Thanks, COVID-19!)
Why is an emergency fund so important?
Thankfully, because I had an emergency fund I could pay the above costs in full. I didn’t have to take out any loans or put it on my credit card. It also reduces the anxiety I have around very stressful situations as I know that at least I’ll be fine, financially.
Building an emergency fund can help you deal with financial emergencies with less stress and prevents you from making poor financial decisions. These financial decisions that we are trying to avoid are:
- Having to take out a high-interest loan to cover your emergency
- Having to sell your investments at a loss because you need the funds
- Having to put the funds on a high-interest credit card
- Having to borrow money from family and friends (I never recommend this!)
And, most importantly:
Neglecting the emergency because you don’t have the money – this may cause the problem to cost even more in the long run. Medical, dental and car issues are all areas in which not spending a small amount of money now can cause greater financial damage in the future.
Having an emergency funds not only saves you money but can also avoid a financial catastrophe.
How big should my emergency fund be?
Most experts recommend that your emergency fund be be 3 – 6 months of your living expenses. So, if you spend $2,200 a month, you should have a minimum of $6,600 saved up.
That being said, this figure should be one that suits your lifestyle and needs. If you have kids or don’t have a stable income, I would save more than 6 months expenses. I work in marketing which is one of the first departments to be let go in an economic downturn. Knowing this, I keep 12 months of expenses in cash – just in case! On the other hand, if you have a stable profession and live at home – a 3 month emergency fund will suffice.
Where should you store your emergency fund?
Short answer, in a high-interest bank account.
Your emergency fund should be immediately accessible, therefore should not be invested in a stock market or “stuck” anywhere such as a term deposit. Yes, you will miss out on gains if it was invested elsewhere, but this money needs to be liquid. This will prevent you from having to sell your investments at a loss or have to withdraw them before maturity.
I recommend finding a bank account with the highest interest rate that you can find. This will ensure that your funds will not deteriorate and keep up with inflation.
Person A: Has a $3,000 emergency to fix their rotting fence, uses their emergency fund to get it fixed and pay it off immediately. Their $3,000 emergency cost them $3,000.
Person B: Their car engine has failed and will cost $3,000 to have it replaced. They unfortunately do not have any cash savings and are forced to put the funds on a credit card with an interest rate of 22%. If they only made the minimum repayments, it would cost them $9,314 over 21.5 years.
Not only would Person B have to pay three times more for the same emergency, they would also be unable to get ahead with their savings and other financial goals as they are tied to debt for decades.
That’s all from me!
If you have any other questions about emergency funds, feel free to send me a DM on insta @themoneymarketerblog or send me an email on firstname.lastname@example.org!