Planning For Emergencies

“Emergency fund” is a buzzword that financial professionals often throw around with inconsistent context.

You may have heard you need three months’ expenses tucked away… or six. Does that number change if you have kids? Or if you are single? If you are living on one income versus two? Do I need an emergency fund if I’m retired? What kind of expenses is an emergency fund for? Let’s explore why planning for emergencies is so important.

Who Needs An Emergency Fund?

The short answer: everyone. If you have monthly expenses to cover, you need to be planning for emergencies. Whether you are twenty-three or seventy-three, a high-income earner, retired, or anyone else, you need one. That being said, an emergency fund is not one-size- fits-all. A retired, single individual living in South Dakota will have a different emergency fund than a single-income family in California.

What Is An Emergency Fund?

An emergency fund is exactly as it sounds, a pool of money you can use in an emergency. This emergency could be losing your job, an unexpected car repair, an extended hospital stay, etc. An emergency fund prevents you from having to fund inflexible expenses with credit.

Let’s say, for example, your furnace breaks in the middle of January. Unlike a dishwasher or washing machine, you must replace the furnace immediately to continue living in that space. The money (let’s call it $5,000) for the furnace must come from somewhere. You can either;

Use money from your emergency fund to cover the expense.
Finance the expense with the furnace company (if they offer it).
Put it on a credit card and pay it later.

Using option B or C will incur tremendous interest charges. Eventually your $5,000 expense becomes $8,000 after interest.

How Do I Build One?

First, figure out what you are going to save. Start with a dollar figure in mind. The range
for an emergency fund is three-six months of expenses. A single-income household of seven should have an emergency fund closer to six months of expenses, while a retired individual may only need closer to three months of expenses saved. Quantify your monthly expenses and then develop your emergency fund goal.

Next, figure out how you are going to save. Make your emergency fund a non-negotiable portion of your budget. Figure out how much you can save each month into the fund after paying fixed expenses. Something is better than nothing, whether it is $50 or $500 per month.

Then, figure out where you are going to save. Emergency funds should be kept in cash, as you need access to liquid funds in an emergency. The best place for an emergency fund is a separate high-yield (if possible) savings account outside your standard checking account. If you start accumulating funds greater than your intended goal, there are other options for your cash, but first start with your emergency fund.

Finally, figure out why you are going to save. Planning for emergencies is never exciting. Like many things, the most challenging part of building an emergency fund is the psychology behind the process. There is no instant gratification with an emergency fund. It is easier to spend $500 now on a weekend getaway than save it for a car repair in four months. It is easier to spend the accumulated cash on other things outside of true emergencies than allow it to lie in waiting for an unplanned expense. Additionally, you may finally have a full emergency fund built, an emergency happens, and you are back to square one, rebuilding that fund for the future. Regardless, find your motivation for saving each month and use that motivation each time you experience a hurdle in building and using your emergency fund.

This article is educational only and is not intended to be investment, legal, or tax advice or recommendations, whether direct or incidental. Again, this is not investment advice. Consult your financial, tax, and legal professionals for specific advice related to your specific situation. Never take investment advice from someone who doesn’t know you and your specific situation. All opinions expressed in this article are those of the people expressing them. Any performance referenced is historical and is no guarantee of future results. All indices are unmanaged and may not be directly invested in.