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An emergency fund is one of the most important tools anyone can have in their monetary toolkit. Money is something we all eventually have to work with and can’t live without. Here are some reasons why you need an emergency fund, and what you need to know.
What is an Emergency Fund?
An emergency fund is exactly what it sounds like. Money that you have available to use during an emergency. This can be anything from car breakdowns, medical or pet emergencies, a house fire, appliance breakdown, and even job loss.
While an emergency fund doesn’t need to pay for every possible emergency at once, it does need to cover all living expenses for anywhere between 1 month to 6 months. Your fund, can of course, cover your expenses for longer if you wish. However, the golden standard is usually 6 months.
What should an Emergency Fund pay for?
Necessities First
Your fund should primarily include the absolute necessities for survival. This could be rent, utilities, transportation, groceries, and any prescriptions you have to take.
The best way to determine how much this would be is to maintain a monthly budget and total up the average monthly cost over time to find your magic number.
Say for example, rent will almost always be the same at a simple $500 a month. Utilities have been varying between $80-150 the past two months, which averages to around $115.
Gas prices over time change, and therefore are more difficult to budget for. So, let’s go with what we have. The last three months I have paid around $250 in total for gas.
While this price isn’t including any maintenance or repair costs, I will eventually need to pay for those, but I’ll get to that in a minute. With gas at a cost of $250 for 3 months, that averages to around $83.33.
Next, I usually pay around $100 a week on groceries, which will average to $400 a month for food. Fortunately, I am not currently needing to take any prescription medications. But for arguments sake, let’s say I have $75 a month in prescription medication.
Now let’s look at what the average cost per month would be for all necessary expenses.
500 + 115 + 83.33 + 400 + 75 = 1173.33
For simplicity, let’s round up to a simpler $1,200 per month. So accounting for 6 months of an emergency fund we’ll need to save $7,200. Sound like a lot? That’s because it is.
But imagine how much worse you’ll feel, and how much worse off you’ll be if you were in a situation and didn’t have that money? You’d more than likely need to take out a loan, rack up a ton or credit debt, and scrounge around for every penny you could get.
You’d be forced to rely more on others for the basic living necessities. Another reason why you need an emergency fund.
Additional Obligations
Aside from the basic living necessities, we all have other obligations. For those with kids or dependents in their care, there is an additional demand on your finances.
There will be times when you need childcare so you can make appointments, or a dog walker to care for your fur baby while you’re out of town for the weekend.
There will also be times when your car breaks down. And while you can ask a friend or coworker for a ride, you will eventually need your own transportation again.
I would consider car repairs to be an additional obligation, rather than a necessity. This is because there are almost always other means of transportation.
However, if you can afford to do so, I highly recommend riding a bike, carpooling, or using public transit when money is tight. If you do decide to carpool, be sure to provide a little money for gas compensation, as this will more likely ensure continued transport with your pals.
Other obligations may include caring for your parents as well. If you have elder parents that require your care, this may be something you need to include in your emergency fund.
However, you should not be going into debt to provide that care. And the same concept applies to providing your children’s college education.
Some other obligations you need to be mindful of include any debt repayments. While you may be able to request a temporary hold on debt repayments, it will not last forever. You should be including your monthly debt repayment into your fund as well.
For this, you only need enough for the minimum monthly payment. I have both student loans and a car loan in which I will need to pay off. Though I am nearly finished paying off my car loan, I will still need to include that into my fund total for now.
I have about $200/month in student loans, and $227/month for my car. This makes a total of $427 for each month. This is now a much more significant addition to my emergency fund total.
So, with the total of $7,200 for necessities, and 6 months of loan payments ($2,562), my total estimated emergency fund will need to be $9,762.00. Why not go ahead and round up that total emergency fund to $10,000? This allows for a little more wiggle room for unforeseen costs.
While it may seem impossible to reach a savings account goal of $10,000 for an emergency fund, it is absolutely possible. But how do we attain this difficult goal?
Simply, with one dollar at a time.
High Yield Savings Accounts
I have heard it recommended by many of my favorite financial enthusiasts, that when creating an emergency fund, it is especially crucial to place this fund into a HYSA.
An HYSA is known as a high yield savings account. The typical APY (annual percentage yield) of an HYSA is usually between 1-4% which is around 10x more or higher than the national average for a savings account.
The Take Away?
Remember that an emergency fund should cover at least six months rent. It should cover all necessary and obligatory expenses. And lastly, it should be used when you actually need it. Free of guilt. That’s why it’s there, right?
How much do you think you’d need to set aside for an emergency fund? Or how much do you think you could contribute to a HYSA?
