Why we all need an Emergency Fund

Why we all need an Emergency Fund

Life is full of surprises. One moment you’re happily going along, the future all planned out, then bam! Something you didn’t expect happens and you are scrambling to react to whatever it is. Sometimes the unexpected is a stroke of good fortune: a financial windfall or an opportunity to follow a long-held dream. However, it could also be a setback; an illness or accident, the loss of a job, or a natural disaster like a tornado, hurricane or earthquake.

While we can do our best to try and prevent unpleasant things happening, often we are victims of unexpected events. As the old Yiddish saying goes: “Man plans and God laughs”! This is a favorite of Mr Frugalitude.

So, while we can’t always prevent bad things from happening, we can choose to be more prepared. One way is to have an emergency fund that can help you with the unforeseen costs of these nasty surprises.

What is an emergency fund?

An emergency fund is simply money that is set aside to cover the unforeseen events that life sometimes throws at us. Basically, it’s a financial safety net that you can lean on in tough times.

Why have an emergency fund?

As I said earlier, life is full of unexpected surprises, some good and some bad, so it’s always good to be prepared. An emergency fund is one way to be prepared for any unforeseen events that might be smoothed by a little extra cash. These could be big crises like losing your job or a medical emergency, or smaller headaches such as unexpected home or car repairs.

An emergency fund will help you cope with many types of emergencies. You can avoid taking out loans or using high interest rate credit cards to cover unexpected costs. You’ll hopefully be less stressed about the emergency because you’ll have the money and won’t need to go into debt.

Who needs an emergency fund?

Everyone! None of us can see the future, so we need to be prepared for the unexpected: “Expect the best, but plan for the worst”. A great way to be ready for unforeseen problems is to have some money saved to cover whatever costs might come up. Of course money isn’t always the complete answer, but it usually has a part to play somewhere in easing the problem somewhat.

But what about if you are already in debt and focusing all your savings to pay it off? Even in this case it is still a very good idea to save money each month to an emergency fund. While paying down debt is very important, it is just as important to try not get into more debt if a crisis occurs.

How much do I need in an emergency fund?

If you don’t have much set aside don’t panic, any saved money is better than none. But many experts recommend that an emergency fund is large enough to cover 3-6 months of expenses.

When calculating your expenses, don’t forget to include all of areas that you have to pay for each month, which could include:

  • Rent or mortgage

  • Insurance

  • Health-care costs

  • Utilities

  • Transportation

  • Groceries

  • Loan payments

  • At least the minimum payment on your credit cards

  • Also, don’t forget the other expenses that occur less frequently; such as car or home maintenance

You probably also spend some of your money on more fun stuff like:

  • Dining out

  • Travel

  • Entertainment

  • Gifts

You can include these in the expense calculation for your emergency fund if you want, but if you need to live off your emergency fund then it is a good idea to cut down on these types of expenses.

If you are not sure if you need 3 or 6 months of savings, here are some things to keep in mind:

  • If you are in a 2-income household or have been in a stable job for a number of years, then a 3-month emergency fund should be OK.

  • However, a 6-month fund is better if:

    • Your income isn’t steady – for example you are self-employed

    • If you work in an industry or for a company where layoffs are more common

    • The economy is in, or heading toward, a recession

    • You want to feel like you have more of a safety net.

When should I start to build an emergency fund?

Start to build your emergency fund as soon as possible. Again, don’t worry if you don’t have anything set aside yet, we all need to start somewhere. Let’s look next at how you can begin to build your emergency fund.

How do I build an emergency fund?

There is no right way to build your fund. It all depends on how much you earn, your outgoings, how you like to save, etc. So here are some ideas to get you started. If you have other great ideas, please share in the Comments section.

  • Automate some savings every month. As soon as you get paid, set up an automatic transfer to a savings account. Automating the transfer means that you won’t forget to do it. If you’re worried about running out of money, start with a small amount. Even $5 or $10 will soon add up over time, and you can always increase it.

  • Save your change. Keep a change jar and empty the coins from your purse/wallet into it. We did this for about a year and managed to save over $120! There are also apps that will round-up the amount of your online purchases so that you can save the change, but if you do choose one of these be sure to check their fees. Here are some of the more well-known apps, with links to their current pricing details:

  • Save your tax refund. Or at least some of it! This can be a quick and comparatively painless way to kickstart your emergency fund.

  • Reduce your spending. Take a look at where your money is going each month to see if there are things you can cut back on. Then you can put the money saved into your emergency fund. If this sounds hard, then perhaps cut back in one area for a month or two, and then try another area – for example, don’t eat out for a month then the next month cut back on another area like entertainment. Or don’t cut something out entirely, just reduce your spending – for example, instead of buying a daily coffee, try buying it only once a week (and be sure to really enjoy it!).

  • Earn more. Another way to get money for your emergency fund is to get another source of income. A second job or side gig could help you build up your fund fast.

  • Sell stuff. Have unwanted stuff lying around the house? Why not sell it and stash the money in your emergency fund. If you don’t know where to start with selling check out my selling tips.

After a few months take a look at how you’re doing:

  • Celebrate that you’ve now got an emergency fund, and it’s growing!

  • See if you need, or are able, to save a bit more.

Where should I keep my emergency fund?

A savings account is a good place for your emergency fund. Just make sure:

  • That you can access your money easily when you do have an emergency and need it. This means avoiding accounts that have withdrawal penalties.

  • It pays interest. Interest rates aren’t great right now, but any interest is better than nothing.

  • The savings account is insured (FDIC in the US, CDIC in Canada and FSCS in the UK).

When should I use my emergency fund?

It’s a good idea to try to keep your emergency funds for the true financial emergencies. A financial emergency is one where you have expenses that you must cover, often immediately, like the loss of a job, sudden medical expenses, or unexpected travel costs to see a sick family member.

It can be tempting to dip into this fund for other stuff like vacations, buying a bigger TV because it’s on sale, or known expenses like car insurance or rent. Once you have your emergency fund established and you’ve saved the necessary 3-6 months, then you can always start another savings account for more fun expenditures like these.

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