Setting Up an Effective Emergency Fund
Setting Up an Effective Emergency Fund
Forrest Gump’s mama had a saying “Life is like a box of chocolates; you never know what you’re going to get.” Now I don’t think she was specifically speaking about wanting Forrest to save $100 out of each paycheck and put it in to a certain account that he will then only access in an emergency situation, but who knows?
An emergency savings account is a bucket of money that you have set aside for life’s “oh no!” moments. We’ve all had the experience of finding a nail in your tire and you take it by the shop only to find out they can’t patch it and it needs to be replaced. If you hadn’t planned for that $300 expense you may need to reach for that credit card, so it’s important we put up defenses to keep us from needing to borrow money just because you got a box of those chocolates you don’t like.
So, the next logical question is “well how much should I have saved up in an emergency fund?” The true answer, as it often is when it comes to personal finances, is “well, it depends.” However, there is a general rule of thumb that you should have 3-6 months of expenses set aside in your emergency fund to defend against life’s unexpected expenses.
How do you figure out where your life situation fits on the 3–6-month spectrum? One factor to take into consideration is your line of work. How quickly could you find another job doing the same thing if you walked into work today and your services were no longer needed? If you could go out and land another job right away, you can probably get away with a leaner emergency fund. However, if you are a high earner and your job is highly specialized you may want to err on the side of caution with a larger emergency fund.
In addition to your job, what is your family situation? If both you and your spouse earn relatively the same amount of income you may be able to get away with a more short-term fund. On the contrary, if you are a sole-earner or there is a large income disparity between you and your significant other then a longer-term fund may be appropriate.
Now that you have a general idea of how much you should have in an emergency account, let’s talk about where to keep this money and how to set it up.
While you can set up another savings account with your current bank the most important thing that you want to consider is that you want this money separate from your day-to-day spending account. You want the account to be accessible in case you need to access it quickly, but not so convenient that you are tempted to pull funds from it in the case of a non-emergency. While a traditional savings account (separate from your savings for other goals) is a fine option for your emergency fund, a high-yield savings account offers easy access to your funds. Additionally, the interest rate you will earn on this account will be higher than a traditional savings account.
By setting up automatic transfers, or direct deposit through payroll, to your emergency savings account you will be well on your way to building up your cash reserves.
The bottom line is everyone needs an emergency fund, no matter how old or what your income is. Planning for what you can’t plan for can be the difference between weathering a short-term financial storm and having to go into debt. By being disciplined about saving into liquid accounts over time, you’ll be better prepared for whatever surprises life throws your way.
