Personal Finance Basics - The Emergency Fund

After getting out of debt, this is the next step to solid personal finance. You can still read this post if you're not out of debt yet, and then you can check out my post about getting out of debt. The peace of mind you will get from having a cash emergency fund may motivate you even more to continue your getting out of debt journey.

So what is the emergency fund? It is 3-6 months of expenses set aside in a savings account. It might earn a little bit of interest but there doesn't need to be anything fancy about it. A money market account will work just fine. It won't earn a lot of interest but that isn't the point of an emergency fund.

Your expenses include things like:

Rent/Mortgage

Food

Transportation

Utilities

Cell Phone

You might or might not include items like subscription streaming services. If an emergency occurs and it's going to take more than a month to refill the emergency fund, some people will pause their subscriptions, and so don't need to include it in their emergency fund. They might pause things that are fun and not necessities until their emergency fund is rebuilt.

The point is to cover emergency expenses. An emergency is something unexpected and urgent. Needing new tires on your car shouldn't be an emergency. Tires wear down and eventually need to be replaced. But if something fails on your car and you had no idea it was coming, that's an emergency. Other kinds of emergencies might be a medical bill, loss of income, or home repairs.

Building up an emergency fund can and should be attacked with similar intensity to getting out of debt. You're doing what you can to increase income and decrease expenses. This means working overtime or getting a second job. It might mean starting a side hustle.

Building an emergency fund will take some time, but it will give you peace of mind and security. When an emergency occurs, and they always will, you won't have to worry about money. It will be an inconvenience but not a financial emergency.

When you use your emergency fund, you will want to rebuild it as soon as you can, get it back to where it was. This probably won't take that long, but you do want to refill your emergency fund.

So should you save 3 or 6 months of expenses? This depends on your situation. If you're single with no children and your job is stable, you can have 3 months. If you do have children in a single income household, you might want to get closer to the 6 month mark. Or if someone in the house is self-employed, works on commission, or has an irregular income, you should be closer to 6 months.

The emergency fund might seem like a waste because it's just sitting there earning little or no interest. But it's not there to earn money, it's there to protect your other investments, so you won't have to withdraw from your 401k or take a loan against your house to cover an emergency.

When something unexpected does happen, you can cover it with cash and it's only an inconvenience and not a financial emergency.

Please leave any comments or questions and feel free to contact me.

Thanks for reading.