Emergency Fund Basics
An emergency fund is money set aside for emergencies. Real Emergencies.
In earlier articles, we have discussed the need for an initial emergency fund for people who are trying to dig their way out of debt. Setting aside $500 to $1,500 (depending on their situation) to cope with emergencies, enables people to focus on paying down their debt, and often removes the need to use credit when emergencies occur. It is a powerful tool that helps people stay on track and get out of debt.
Once you have paid off your unsecured debt and are left with only your mortgage – what then?
This is where it can get a little daunting – but ideally, now is the time to increase the size of your emergency fund to a level that will cover three to six months of your expenses. The more unstable your income, the more you should have in your emergency fund.
Relying on credit as your only emergency fund is short sighted, as you will not only have to cope with the emergency, but you will then have the added burden of debt and interest charges.
Basically, an emergency fund is your shield against having to use credit as a source of income.
What is an Emergency?
Let’s start with what it is not – it is not a great sale on shoes, it is not a vacation, it is not the latest electronic toy, it is not a hot tip on a horse/stock, and it is not any purchase that can be reasonably put off.
An emergency is an essential and unexpected expense that you cannot put off – for example – fixing the car that takes you to work, repairing the leaking roof, and visiting the dentist with a tooth ache.
As your financial situation improves, and as you develop skills in budgeting, there are many things that you will be able to plan and save for – that will help to reduce the number of emergencies you have to face – ie:
- Car Maintenance
- Home Maintenance
- Dental Check Ups
What Happens if the Emergency Fund is Used?
If money from the emergency fund is used, it must be replaced asap.
If you are in the process of getting out of debt, you may have to rebuild your emergency fund by making minimum payments on your debts and putting the rest towards your fund.
If you are out of debt and have to use your emergency fund, then you will need to refund it as soon as possible by putting non-essential spending on hold.
How To Set Up and Keep Your Emergency Safe?
To help keep your emergency fund available in case of emergencies, but safe from unnecessary use, it may be wise to:
- keep you emergency fund in a separate bank account,
- do not have debit card access to your emergency fund, and
- get the best interest you can without risk or tying up the fund for a period of time.
Some people like to keep a small portion of their emergency fund in cash, at home and in a safe hiding place. There are good and bad points to this approach, and you must carefully consider what is best for you and your family.
How To Get Money for an Emergency Fund
Properly funding your emergency fund requires consistency and follow through. Depending on your situation, you may need to:
- Sell some of that useless stuff that is laying around your home.
- Cut back on your ‘entertainment’ expenses. Forego things like meals out, going to the movies, buying lunches, vacations, etc.
- See if you can get a temporary, second job to build up your fund.
- Cut down on your non-essential expenses.
- Track your success in building up your emergency fund – make it a priority.
If you have successfully completed paying off your debts – you can start saving for your full-size emergency fund by putting the same amount you have been using to pay down your debt, into building up your emergency fund.
There are many things in life that you cannot control – but the security of a emergency fund is one of the best ways you have of shielding your family from unnecessary hardship.