Sometimes, financial success can be exciting. It’s exhilarating to finally get the raise you worked so hard for, buy your dream house, or take your long-awaited European vacation guilt-free.
But some sound financial concepts are boring. Emergency funds are definitely snooze-worthy. After all, they are there to help you sleep soundly at night. Emergency funds provide a buffer to help you navigate the unexpected ups and downs of life, from car repairs to job loss to even cleaning up your living room after a wild turkey break-in.
How Much Should You Have in an Emergency Fund?
For most families, setting aside 3-6 months of take-home pay is enough.
If you’re single, a homeowner, or have a very specialized job that’s difficult to replace, you’ll want to have closer to the 6 month mark. If you’re married, and the two of you work in unrelated industries (i.e. something like engineering and teaching), you can be closer to the 3 month mark. If you’re a business owner, you might need even more than 6 months to weather a dry spell in the business.
But if you feel the need to just hoard the cash, remember that too much in cash in an emergency fund might keep you from meeting your financial goals. Unless you rely on a variable income, a year’s savings is more than enough.
Establish the Savings Habit
If you don’t have much in savings, piling up a ton of cash might be intimidating. If that’s so, aim to get to one month of take-home pay in savings as a first goal. You’ll be establishing the habit of putting away a little extra in savings every month, and your buffer will likely grow over time.
If you have a mountain of student debt, you might want to throw any and all extra cash towards that debt. Even then, stick away just a little every month for your future self. The habit of saving a little every month is essential to your financial well-being, so it’s important to begin saving no matter your starting point.
Use Your Take Home Pay
Three to six months of take-home pay is a large sum, and you might be wondering if it’s really necessary to cover your entire paycheck. You might think it’s enough to save for non-discretionary expenses.
Consider aiming for the full take home pay. It’s simple, and hard to fudge. It’s too easy to say that some expenses — say eating out– aren’t essential when you’re saving. But then when it comes time to cut back, it’s easy to justify the opposite. That dinner and drinks is networking, right? Besides, it’s not always easy to change your spending habits, especially in stressful times.
Where to Stash the Cash
Now that you have a growing emergency fund, you might wonder if you really need to keep your emergency fund in a savings account that’s making pennies on the dollar. After all, you’re trying to make the most of your money.
But remember: Your emergency fund is not there to make money. It’s there to help face the unexpected.
Your emergency fund should be easy to access, and not exposed to the whims of the market.
Imagine if you were a tech employee relying on company stock back in 2000. If the company went bankrupt, you’d be out of a job with no emergency fund, and your portfolio would be in shambles.
And no, a home equity line isn’t enough. After all, your house could lose value right when you lose your job. Millions of families experienced this during the last recession.
Keep the money in cash in a boring account like a money market or savings account.
When to Use Your Emergency Fund
Once you’ve managed to accumulate your pile of cash, you might feel a bit protective of it. But it’s there to be used in the right circumstances.
When you lose your job, use your emergency fund! It will buy you time to help you find the right job. When an expected car or home expense comes up, use your emergency fund. Fix the problem, and then pay yourself back in time.
But let’s be honest: some things aren’t an emergency, even when we really wish otherwise.
Your friend invited you on an amazing trip, and you really want to go. Nope, not an emergency. If you want to travel on a whim, set up a travel fund so you can do exactly that.
Other things, like property taxes, buying a new car, or paying a health insurance deductible, can be expensive. However, all of these expenses can be anticipated. Your property taxes happen every year. You’ll know when your car is getting older. An emergency fund is meant to be used for the the things you can’t plan for. If you rely on it for every large expense, it won’t be there when you need it.
Just Start Saving
There are numerous ways to set up something as basic and boring as an emergency fund. But it comes down to this: do you have something set aside for the unexpected? If not, start saving. You’ll need it.
About Your Richest Life
At Your Richest Life, Katie Brewer, CFP® works with busy professionals to help them organize their financial life and make progress on their goals. For more information on the services offered, contact Katie today.