The idea of having an emergency fund is not new. Practically every financial blogger, adviser and guru will tell you that emergency savings are something everyone needs. What they don’t all agree on is how much emergency savings you should have. Recommendations range from a set amount like $500 or $1000 to projections based on your current monthly income and expenses, such as 6 or 12 months of living expenses. Who is right? I think that depends on your own situation as well as your tolerance for risk and possibly your inventiveness, motivation and drive.
One thing I am sure of though is that you don’t need just one emergency fund. You should have a long range emergency fund to protect against job loss, but just as importantly you should have a smaller sudden emergency fund for the emergencies that occur more frequently and have lower associated expenses.
How Big Should A Sudden Emergency Savings Fund Be?
Let me first say that there are really two types of emergency funds. The one I will be discussing today is a short term sudden emergency fund. This is one you would use for sudden emergencies such as a car breaking down, unexpected small medical expenses or any sudden unexpected expense. This type of fund should be a top priority for everyone and should remain fully funded at all times. What I mean by that is if you have to use these funds you should replace them as quickly as possible. Murphy is always ready to strike and in my experience when he does so once he often does so again fairly quickly.
This sudden emergency fund should be a minimum of $500 and a maximum of $1000. How do you decide which amount to use? Well part of that is up to your own tolerance for risk, but in general I would say those who are in the most trouble financially need to have the most in this type of savings. If you are just able to make your monthly payments you are in greater need of a larger sudden emergency fund. If you don’t have the funds necessary to cover a sudden emergency you are the most likely to tap a credit card and go further into debt when disaster strikes.
Those who are already able to save 10% or more of their income have a bit of breathing room because they could use their monthly savings for an emergency and they can also tap into those savings to replenish their sudden emergency fund when it becomes depleted.
Just so you know, the second type of emergency fund is meant for longer term protection. This is a savings fund to protect against job loss that can occur for whatever reason be it layoffs, a firing or even if you want to strike out on your own. Nick at Step Away From the Mall calls budgeting for emergencies his eighth rule of budgeting (you’ll have to head over there to find out what the other rules are).
How Do I Create A Sudden Emergency Savings Fund?
No matter what your financial picture right now you want to focus 100% on getting the sudden emergency savings set up as quickly as possible. There is no telling when you will need this money and the sooner you get prepared the better off you will be when an emergency does strike.
If you are in the group that has discretionary funds to save already, you should find it relatively easy to set up a small sudden emergency fund of $500. Yes it will be somewhat disheartening to derail your savings plan, but the first time you have to tap into the emergency savings you will be glad you sacrificed somewhat to put this savings fund in place. You have the extra money to put aside, so just do it.
Those of you who are living paycheck to paycheck or have expenses in excess of your income are going to have a harder time of it, but truly you are the ones who need this emergency savings the most. If you fall into this category, the first thing you should do is to attempt to balance your budget or even better create a budget surplus. If you can do this, it will be easy to set up your emergency fund and you will continue to reap the benefits going forward as you will have discretionary funds to pay down debt, save for retirement and improve your financial situation in general.
If you see no way to find the $500 to get this emergency savings in place you might need to get creative.
Snowflaking is one method that might get you to $500 in time. What about selling some of your stuff? You can use eBay, Craigslist or even an old fashioned yard sale to sell off some stuff and make the $500 you need. Donate plasma or sell your hair (yes you can). You could even get a part time job to fund the account.
Where Do I Keep My Sudden Emergency Savings Fund?
Because this is money you will need quick access to the best place to keep it is in a separate account at your local bank or credit union. Some might recommend using an online savings account, but that risks delays in having access to your money and honestly in this environment the extra 0.3% annual interest you would get on the $500-1000 is negligible. Some might even say you could keep the money at home for even quicker access. I wouldn’t recommend it though. Not because of thieves who might break into your home, but more because you would be tempted to “rob” the fund yourself.
Which leads me to one final point. Do not under any circumstances use this money for anything other than a true emergency. Forgetting to pack lunch for work is NOT an emergency. Running late and having nothing planned for dinner is NOT an emergency. Shoes, video games, clothing, electronics or any other consumer items are NOT emergencies. I think you get the point.
Now that you have a plan in place put it into action. Some of you will be able to fully fund this account in 1 month, which is great! Others might take 3, 6 or even 9 months to fully fund their emergency savings account and there is nothing wrong with that. The process will be instructional for you and it will teach you something very important; how to save. Once you fully fund the emergency savings add whatever amount you have been saving each month to your budget. You are officially a saver and on your way to bigger and greater things such as a long term emergency fund and even your own investments. Financial security isn’t something that comes overnight, rather it is a long slow progression of actions.
I personally have a sudden emergency savings account that is equal to about $650. We used part of it last month for an emergency trip to the doctor for my daughter. The very first thing I did this month when my wife and I got paid was to replace the savings we had used.
What about you? Do you already have a sudden emergency savings fund? What prompted you to set it up? Have you ever needed those funds and if so did you replace them promptly? What other tips might you have to help people new to emergency savings get their accounts funded as quickly as possible?