Pink ceramic piggy bank

You Need an Emergency Fund

Don’t you hate it when people tell you what you need to do? Me too, but follow me on this one. I promise it’s important.

When it comes to life emergencies, it is not a matter of if, but rather, a question of when. Age doesn’t matter. You could be a young, single college freshman or middle-age and married with three kids. Life will eventually throw you a curve ball. Maybe it’s nature’s way to keep us all humble. Regardless, you need an emergency fund to minimize the negative impact.

If you don’t work in the federal sector, you likely forgot the government shutdown at the beginning of 2019. This was the second shutdown I experienced while working in the public sector, and it was daunting to hear some of my colleagues fret about their inability to pay the bills. Part of me felt sympathetic . A different part of me wondered how someone twenty years my senior with decades of secure employment could allow themselves to live paycheck to paycheck.

This is the part some of you will hate; some people generally dislike people who appear to flaunt their success. Yes, I navigated both shutdowns just fine. I had ample savings to keep me afloat, but listen, I did not succeed because I was lucky or got special assistance. I survived missing a few paychecks, because I had saved up enough money to absorb the impact of such an emergency. This is not me flaunting. This is me expressing faith that you too can do it.

What Are Emergencies?

Before we get into how to build an emergency fund, let’s get on the same page about what qualifies as an emergency. Remember what I said about planning with a purpose?

You should not take money out of your emergency fund so that you can:

  • Take advantage of a sale at the mall
  • Buy the latest smart phone
  • Come up with the difference for a weekend getaway
  • Pay for the happy hour with your colleagues you hadn’t budgeted
  • Remodel your kitchen
  • Upgrade your wardrobe
  • Lend your friend or family money

These are just a few examples of the sort of actions that should be covered by a savings account. I promise the world will not stop spinning if you temporarily deny yourself any of these scenarios.

A few of you may scoff at the last bullet. Why would you not loan money to someone who is struggling if you have the available cash? The situation has many nuances and requires its own post. For now, it’s enough to say the airplane safety analogy holds true here: You cannot help others if you are not taking care of yourself first.

Examples of justifiable emergencies would include things like:

  • Sudden unemployment
  • Unexpected medical attention
  • Repair costs not covered by insurance
  • Theft
  • Vet emergencies

These conditions are generally unforeseen. They can have an immediate impact on your daily living and will very likely have a ripple effect on anyone who depends on you.

How to Set Up the Emergency Fund

First, make a calculation about how much it takes you to survive in one month. This calculation should take into account your housing, bills, food expenses, tuition, and any other expense you would deem essential. Really, give my budgeting article a glance.

Tip: Your subscriptions to streaming services would not be considered essential.

Second, decide how long the emergency fund should cover you. If you were to lose your job or other financial support, how long would you want to be able to lean on this emergency fund? There is no right or wrong answer. I would personally recommend no less than three months. The period should be longer the more people you have depending on you.

These are some questions you might want to consider:

  • How long would it take you to find employment again?
  • Will the first emergency trigger secondary emergencies?
  • Are there fluid conditions like medical needs that could become a problem?
  • How many people rely on your income?

Next, you want to find an account with competitive interest rates to store your emergency fund. High yield money market accounts could be better than traditional savings accounts, but do your homework on which accounts are delivering the best return at the moment. Remember, this is somewhat relative since interest rates are terrible at the time of this writing. Nevertheless, 1 percent is still better than half a percent.

The account should be separate from your primary bank. The emergency needs to be built up and then largely forgotten. You don’t want to easily act on your temptation to use the money for something frivolous.

Make sure you can link your primary account to the financial institution holding your emergency fund. You should never have to pay fees for moving money back and forth.

The Emergency Fund and the Rest of Your Financial Plan

Building an emergency fund should not always be the first goal in your financial plan. If you have credit card debt with an astronomical interest rate, that hurdle should probably be cleared first. That is, of course, only my personal opinion, but carrying a large debt has a way of draining us emotionally. Also, just because paying off your debt is your top priority does not mean you have to give up on saving altogether. It might just mean that your savings rate will be low at first. Later, after your debt has been paid off, you can take that monthly deposit and reroute that toward your savings, because by then you will have gotten used to living off a smaller budget.

However, an emergency fund should come ahead of other financial goals. Saving up for a trip to Europe is an exciting goal. If you die, you won’t take any of your savings with you, but in the more likely chance that you will live, a European vacation is not more important than setting money aside for a rainy day. Set up the emergency fund first, and then focus on saving up for Europe.

Even noble goals like saving up for the down payment on a home should not come ahead of an emergency fund. Conventional advice says you should save up to 20% of the property, but the down payment is not the only expense you will face when buying your own place. You will want a financial cushion to absorb the miscellaneous fees leading up to and at the closing. Also, remember you will want to decorate and maybe bring in new furniture. Those costs also need to be calculated into your final total.

Here’s an important thing to remember about emergency funds. Regardless of the timeframe you settle on, you should never stop setting money aside. I am generally against automatic transfers. I like to be in full control of my cash flow, but automatic transfers into a savings or money market account, even twenty dollars here and there, is one area where I can see a viable exception.

Final Thoughts

No one will ever care more about your financial stability than you. When you experience one of life’s inevitable dips, you want to be in a position to bounce back from the blow with minimal impact. It’s going to be slow. You’re going to think of all the things you could be saving for, but trust me, you will sleep better knowing there is a stash of cash somewhere available when you need it.

What do you think? Do you have any questions? Sound off in the comments!

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error: You may not copy without written permission by Joe Orozco.