Well, before we get to the answer, let’s determine what an emergency fund is.
Emergency Fund Definition
- It’s basically a separate savings account that you keep for a rainy day and no, I don’t mean the day you need to take an umbrella with you. It’s when something unexpected happens and you MUST take care of it. An example could be medical bills, car repairs or replacing the water heater. I’m sure you can think of many others.
If an event like one of these occurred in your life, what would happen if you didn’t have the money readily available to take care of it?
When you think about it like that, it becomes pretty obvious that an emergency fund is essential. However, research has found that 26% of Americans have no emergency fund whatsoever for when they need money fast.
Moreover, this same research concluded that only 40% of families have enough savings to cover three months of expenses, with an even lower percentage having the usually recommended six months’ worth of savings.
Not only is an emergency fund essential for taking care of unexpected bills, it gives you the peace of mind knowing that if something were to happen, it wouldn’t be a catastrophe.
Another advantage to having an emergency fund is that it can help to prevent unnecessary debt. Using a credit card as an emergency fund is not a good idea since the interest rate on most cards is very high and this can cause your debts to spiral out of control very quickly.
How Much Should Your Emergency Fund Be?
Well that depends on your specific situation. However, if you are not in debt, it is recommended to have at least enough to cover 6 months of expenses.
If you are in debt then an emergency fund is still recommended, and again it is tailored to your circumstances but you should look to have at least $1000 in your disaster emergency fund to cover emergencies.
Where Should You Keep Your Emergency Fund?
More than likely, if you ever need to use your disaster emergency fund, you will probably need to access it quite quickly. This means that you won’t want to keep it in an account that penalizes you for taking it out and you won’t want to keep it in a high-risk account in case you lose it.
It is recommended you invest your emergency fund in a low risk savings account such as a basic savings account at your bank. This way you can easily access the funds if anything were to happen and you needed the money quickly.
If you are fortunate enough to establish a significant amount in your emergency fund then consider splitting the fund so that some is left in your savings account and some is kept in a CD that could receive a better interest rate.
How To Save An Emergency Fund
Let’s face it. Unexpected things happen in life and we need to be prepared for them. It’s not going to be easy to save an emergency fund but it is essential we do and we have to start somewhere.
Consider setting aside a certain amount from each paycheck or look in to the many ways you can make a little extra money so that you can build your emergency fund even quicker.
Whichever method you choose, make sure you follow through and do it. You will be thankful one day.