Life can throw you curveballs and if you aren’t prepared financially, these curveballs can turn into major problems. That’s why it’s so important to have a savings buffer, also called an emergency fund. An emergency fund is a cash account that you keep separate for life’s unexpected events. It can help prevent additional stress when these events occur.
Here are some scenarios where you may need an emergency fund:
- Unexpected car repair
- Unexpected home repair
- Unplanned medical expenses or emergency room visits for you, a family member or a pet
- Unexpected job loss
The first step is to figure out how much money you should have in your emergency fund. Keeping three to six months’ worth of expenses is the proper amount for most people. If you have less than 3 months’ worth of expenses saved up, now could be a good time to work on that to avoid a risky situation. It’s very plausible to be out of work for that amount of time and have reduced or no income coming in. It’s important to remember that a credit card is not an emergency fund, and an emergency fund prevents you from having to take on debt to get by.
For some people, having more than six months’ worth of expenses makes sense. If you are a solo business owner, if you’re in a high turnover job/industry, you have a highly variable annual income, and/or you have frequent recurring medical expenses, then 6 to 12 months’ worth might be more appropriate. Keeping more than 12 months’ worth of expenses in your emergency fund is more conservative than most people need to be. That additional money can be put to work for you through investments. It’s important to note that holding a large amount of cash/liquid assets for a goal such as an upcoming house down payment is wise, but that money is for a separate goal and shouldn’t be considered part of your emergency fund.
The next step is deciding where you’ll keep your emergency fund. The key is that you want the account to be liquid. This means that the funds will be in cash or very short-term securities that allow you to have access to this money immediately. This could be a separate bank account, a money market fund, or a high-interest-rate savings account option like we have here at Merriman. Please reach out to discuss which type of account makes the most sense for you.
The final step is saving up and building your emergency fund. Start by figuring out your monthly cost of living. This can be done by creating a budget and sticking to it. Read our budgeting article on the Merriman blog to help you do this. As your family status, job and goals change, make sure you adjust the size of your emergency fund accordingly.
You now know what an emergency fund is, why you need one, how much money should be in it, where it should be stored and how to build one. If you need help with any or all of these steps, please reach out!