Most personal finance gurus agree, once you meet your basic needs and any monthly payments, the first thing you should consider is starting an Emergency Fund!
What is an Emergency Fund?
This may seem like a no-brainer, but an emergency fund is easily accessible money set aside for use only in case of emergency. This means no using it for a new pair of shoes, a new car, a date, or remodeling of any kind...only an emergency!
Why do you need an Emergency Fund?
Scenario #1: It's the end of the month, you've finished paying your bills, and you have just enough money left for groceries when...BAM!...a flat tire. You pull over, get out of your car, and open the trunk and...BAM!...you don't have a spare. What now?
Scenario #2: It's 100 degrees outside in a good old, St. Louis summer. Your air-conditioner goes out in your house or apartment. What now?
Scenario #3: You lose your job.
You get the picture. If you have an emergency fund in any of these situations, you're going to come out of it much better. Studies even show that people with emergency funds are less likely to accumulate debt. Emergencies happen to everyone, not just middle-aged people with full-time jobs and families. Even college students will benefit from these types of funds!
How much should be in an Emergency Fund?
While everyone needs an emergency fund, the amount of it usually varies with the situation. If you're a 20 year old college student, chances are you can't afford to have a fund that amounts to a year's salary. You can however, start small and grow your fund as you get older.
Do what works for you. Examine your income and your expenses, then decide what you should save. While I am sure there are people who have a year's salary tucked away, most experts agree that $1000 is a good place to start...of course you need to build up to this also.
How do you get started?
First, examine your expenses. Make sure you are paying your bills on time and meeting any other goals before you start your account...an emergency fund shouldn't cause debt, it should help prevent it. Also, if you're in the habit of depositing a certain amount of money monthly into your savings account, don't stop! Use your own judgement to decide if this money should be used to help you start an emergency fund, or if it should be completely separate.
If you're worried about using your savings account to store the emergency fund, I recommend opening a new account. Start by depositing $100. If that worked out, try a larger amount, and so on. Once you find a good monthly amount to deposit, stick with it until you think you have a sufficient total amount. It may also be wise for you to keep these funds in an account that is less accessible than others; like one that does not have a card tied to it. This may help you consider all your options before dipping into the fund.
What the experts say.
Though experts agree emergency funds are a must, there are many different views on them. David Bach, author of The Automatic Millionaire, recommends following these three steps:
- Decide how big a cushion you need. Three months worth of living expenses or more.
- Don't touch it. "The reason most people don’t have any emergency money in the bank is that they have what they think is an emergency every month…A real emergency is something that threatens your survival, not just your desire to be comfortable.”
- Put it in the right place. “Not earning interest on your emergency money is almost as bad as burying it in your backyard.”
On the other hand, David Ramsey, author of The Total Money Makeover, recommends starting by saving $1000. Once debt is eliminated, Ramsey suggests building a three- to six-month cushion.
You may feel like you can't afford an emergency fund, but the truth is you can't afford not to have one!