What is an Emergency Fund & why you need one

Are you trying to figure out this money stuff and confused about all the terms and just want to know what you need to get ahead? Well let’s start with savings and what an emergency fund is. An emergency fund is a savings account that is set up for unexpected expenses that are urgent and not planned. So that means an emergency fund is for the unknown. You might be thinking, how is that different from a savings account. Well technically it is not. They way you label and think about it is what the difference is. I literally have a separate account set up for my saving and another one for my emergency fund. I even label the accounts so I don’t forget the job I have assigned to the money that is in that account. Did you catch that? I tell my money what its job is and make it work for me. I don’t just spend and wonder where it went. Saving is both a task and a skill I think. It is something you should do and something you can learn to do.

So why do you need an emergency fund that is separate from your savings? Its so you can sleep at night and not worry about what might happen and how you are going to cover the cost. An emergency fund should be 3-6 months of your basic needs cost so that you can have a bridge to get you from doing okay over the issue that comes up and back to being okay again. When I am talking basic needs cost I mean food, shelter, transportation, insurance and utilities. I would not include monthly subscription costs, personal spending allowance, clothes or other costs that make life comfortable. This money is just meant to help you in crisis mode. So that means it would not be equal to what you budget for each month. If you are married and have a two income household with reliable paychecks then you only need the 3 month emergency fund. You may flex that up from 3 to 4 or 5 month depending on your comfort level with the number in the bank. If you are self employed, have an irregluar income, single income household things might feel a little less secure, so that means I would recommend a 6 month cushion in your emergency fund.

I guess we should define emergency in some examples so you really know what I am talking about. Let’s say you only have one car and the altenator stops working and you live in a rural area where there is no public transportation. This would be a case where I would use some of the money in the emergency fund to fix the car and get back to making money. Next example: You get let go from your job and they give you a $10,000 serverance package and you get highered at a new company in one week. Oooo that’s tricky. While it is unexpected the money you got as severance is meant to help bridge the gap in employement so you should not need to tap into the emergency fund since you got a job right away. Now let’s pretend you forgot you are supposed to host an event for your kids friend group and there are 20 teenagers coming over. While this is urgent it was planned you just forgot and the money should have been set aside in your budget in a separate account. This is not an emergency. So the keys to remember here are Urgent, Unplanned, and Unexpected. If something can wait and you can save up please do that, only take money out of the emergency fund if you absolutely have to.

So what happens if an emergency does come up and you take money out? Then you start to rebuild it once the emergency has past and been paid for. If you are comfortable with 4 months worth of expenses saved and you have to spend 1/3 of that on an unplanned and urgent event that you were not expecting, then you set a new savings goal to build that emergency fund back up to the full 4 months as soon as possible. With an emergency fund set up you will feel more freedom and security with your money. You will no longer fear the what ifs financially because you will be prepared to cover them in cash. You become your back up plan.