Life likes to stay interesting and, to do so, it throws us curve balls every now and again. Being prepared for these unexpected events is the core reason you want an emergency fund.
Your emergency fund is money set aside that is only to be used in the event of an emergency. This isn't your savings for a down payment or your investment money. This is truly funds set aside and not touched unless needed.
It is recommended that you be able to cover three months of living expenses with your emergency fund. Some people advocate for six months and I even know people who have saved twelve months worth of expenses! Your primary goal should be for three months, then work up from there.
The emergency fund has a few benefits. First, when you have an emergency you don't have to worry about where the money will come from to pay the bill. You will have one less headache and in a stressful time, that will be much needed. Second, and sometimes overlooked, is that an emergency fund helps keep your financial life on track. When an unexpected event occurs, you don't want to have to use high interest rate debt such as credit cards or loans. This simply makes the matter worse because now you have a stressful situation to deal with and you will be paying interest on the amount you borrowed.
How to Build Your Emergency Fund
When you are going through the process of creating a budget you should be sure to include a line item for your emergency fund. If possible, try and make this about 10% of your take home pay. Some financial planners like to say 20%, but if that is too much at this time then commit to a lower amount for now.
Keep it liquid. This means that you should be able to access your funds at a moments notice should a situation arise. Think about keeping your emergency funds in a savings account at your bank separate from any other savings accounts. Your interest rate on your money will be extremely low (as of this writing), but remember, this is not your investment fund. These are funds to get you through a rough patch. By keeping your money liquid it ensures that you can get it when needed. If you decided to invest in mutual funds or stock portfolios, you would have to sell the securities and wait for the funds to settle before transferring to your bank. Additionally, investments may lose value and you may find your emergency fund is not as large as you thought due to losses.
Building your emergency fund will take some time and commitment. However, it is an important piece of your financial life that you should address at an early age. If you aren't already saving, go back to your budget and figure out a way to begin today. Your emergency fund is like insurance and, as the saying goes, "It's better to have it and not need it, than need it and not have it".
Emergency Fund Tips
Need some help boosting the savings in your emergency fund? Check out these ideas:
1. Track your spending - Every dollar, every day. What can you eliminate (I'm looking at you daily Starbucks trip)
2. Find a side job - Tutor, Uber driver, selling old items you don't use. If you can find a way to earn some extra income go for it!
3. Rethink "needs" - Look at your spending habits, especially monthly subscriptions. What do you reallyneed and what is just something you like having? Wants can hide as needs and removing unnecessary expenses frees up more capital for savings.
4. Automatic bank transfers - Schedule an automatic transfer so that once you get paid a certain amount of funds goes right to savings before you can spend it.
There's an App for That
There is an app for everything. Check out these apps below to track your monthly spending by category.
BillGuard (Prosper) - iOS/Android compatible and free (paid if you add extra services)
Goodbudget - iOS/Android compatible and free (paid if you add extra services). Makes use of "envelop" budgeting where you set a monthly allowance for each expense category.
Penny - iOS/Android compatible and free. Penny helps keep track of your spending and finances via fun and friendly text messages.