Murphy’s Law is typically stated as: Anything that can go wrong, will go wrong. And if we don’t have an emergency fund we are risking going into debt when Murphy comes knocking on our doors.
According to the most recent Bankrate’s Financial Security Index survey, 26% of consumers have no emergency savings and another 24% have less than three months’ expenses. I was one of these people not too long ago.
And this is not just an issue with low-income Americans, more than 25 Million middle class American families are living paycheck to paycheck and have little or no savings. This staggering number proves that regardless of how much money we make, we have a savings problem.
What is an Emergency Fund?
An emergency fund is simply money you set aside for an emergency or “for a rainy day” like grandma used to say. These emergencies include: the loss of a job, emergency car repair, sudden illness, house repairs, etc.
An emergency fund is not to be used to book a vacation, to buy a new car, or to get the latest 72-inch High Definition TV. You should have a different fund for these things.
Why do I need an Emergency Fund?
Unexpected things happen all the time. Just recently Dee S wrote how her basement got flooded and she and her husband now have to put more drain tile on their basement. Luckily, she had an emergency fund in place and didn’t have to go into debt to get it fixed. Did I mention this happened only a few weeks after her car sustained $7,500 worth of hail damage? Her insurance paid for the damage, but she had to pay the $1,000 deductible out of pocket. Rough few weeks for Dee.
A few weeks ago I wrote about the documentary Spent and how some of the situations in the documentary could have been avoided by having an emergency fund and with a better financial education.
Also, with our shaky labor market, we just don’t know when we are going to get handed that pink slip. It’s good to have a nice cushion to cover the bills while we look for that new job.
These are just a few of hundreds of examples of why we need an emergency fund.
How much do I need in an Emergency Fund?
This question is hard to answer because it all depends on your particular situation and it also depends on who you talk to. Some financial experts say you can have as little as $1,000 while others say you should have as much as one year worth of expenses.
However, the consensus is that we should have between three to six months worth of expenses as an emergency fund.
Just remember that expenses do not equal our monthly take-home pay – at least it shouldn’t. If your take-home pay is $3,000 and you’re saving $500 then your expenses are only $2,500. While it doesn’t hurt to save more, knowing exactly how much you need will help you accomplish your savings goals faster.
How do I start an Emergency Fund?
Starting an emergency fund is as easy as depositing $100 into a savings account, preferably a high interest savings account. Just remember to pay off all your debt before starting the emergency fund.
After you have paid all your consumer debt, your goal should be to save 3-6 months worth of expenses as an emergency fund. It is always good to set a goal. I set little goals for myself and felt a sense of accomplishment every time I reached those goals.
The best way I’ve found to save for an emergency fund is to treat it as a bill and pay myself first. As soon as I receive my paycheck, I pay myself before I pay any other bills. You should first determine how much you can save each month and this is easily accomplished by having a written budget.
Where should I stash my Emergency Fund?
Our emergency fund should be easily accessible, but not too easily accessible. What I mean is that you should not have it tied up in investments, but also not in an account that you use on a daily basis.
You can open an account at an online bank or at a credit union that pays you interest, where it might take you a few steps to get that money in your hands. You don’t want to be tempted to use that money when you come across an awesome deal on those shoes you “must” have.
I have my emergency fund in the credit union at work which pays 0.87 APY. It’s not much, but I also don’t have that money tied up and I can access it with a few steps. I have to either drive 10 minutes to the branch or I have to transfer the money from my savings to my checking before I can use it. Not that difficult to do, but it makes me think twice before using that money for non-emergencies.
If you want to keep Murphy at bay, you better start that emergency fund as soon as you can. Having an emergency fund won’t stop Murphy’s Law, but it will prevent you from going into debt when something happens.
I don’t want to sound like a broken record, but remember to first have a mini emergency fund of at least $1,000, then pay off all your consumer debt, and then continue building on your emergency fund until you reach at least three months worth of expenses.
Do you have an emergency fund? How many months worth of expenses do you like to keep in your emergency fund?