If you’ve never had a financial emergency come up at a really inconvenient time, you’re in the minority. The truth is, unexpected financial burdens happen to almost everyone – and by definition, they’re never at a good time. While you can’t prevent most of these situations from happening, you can do your best to be financially prepared. And a good place to start is with an emergency fund.
An emergency fund is exactly what it sounds like – money that’s put aside for an unexpected cost and is kept separate from your main spending accounts and not earmarked for any other expenses. Obviously, a suitable time to start building an emergency fund is before you find yourself in a situation with unexpected emergency costs. As a financial advisor in San Antonio for many years, some of the more common types of financial emergencies I’ve seen over the years include:
- Job Loss – This is arguably the reason most people establish an emergency fund in the first place. If you or a spouse were to lose the primary source of income for your family, would you be able to continue living in your home and paying your existing bills until you found a new job? If not, it’s a good reason to start saving now. Consider your dependents, including family pets, as well as important activities in your family’s life. No one wants to have to change their lifestyle abruptly.
- Home Repair – While some home repairs are minor, such as a broken dishwasher or a broken fence, major home repairs can be costly. For example, a roof replacement can cost up to $15,000 and re-plumbing a home can range from $1,500 to $15,000+. That means you could be one fallen tree or busted pipe away from a financial crisis if you don’t have an emergency fund.
- Medical Care – Emergency medical needs can arise for anyone at any time. When planning your emergency fund, it’s wise to consider not only the health of the primary income earners, but also any dependents. If you have an elderly relative that depends on you for care, and he or she gets sick, you could be out of work during the time you’re needed at home. Establishing an emergency fund means you don’t necessarily have to choose between paying the bills and taking care of a loved one.
- Car Repair – For many people, a vehicle is the way they get to and from work. Without it, their income could be affected. Therefore, it’s crucial to keep your vehicle in working order. An unexpected vehicle repair could have a major financial impact. As an example, a new transmission could cost anywhere from $1,800 to $3,400, depending on the make and model of your vehicle. Perhaps you get into a crash and your car can’t be driven – do you have funds set aside for a long-term car rental?
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It’s never fun to dwell on all the negative events that could happen in your life. But it’s something that I believe everyone should at least consider.
On the flip side of this, there are some positive things that are not financial emergencies but might help you see the importance of an emergency fund. For example:
- Vacations – While fun and probably much-deserved, vacations are not considered a financial need. Instead of using your emergency fund, I recommend clients set up a separate vacation fund so they can take a break without putting their finances at risk. However, an emergency fund can affect your vacations – consider what would happen to your highly anticipated trip to the coast if one of the emergencies above occurred and you didn’t have the money to take care of it? Would you still be able to take time off? Or would you have to dip into your vacation fund instead?
- Regular expenses or bills – If you find yourself using your emergency fund to cover your regular monthly bills (with the exception of job loss), you probably aren’t living sustainably. If this is happening regularly, I recommend revisiting your monthly budget to see where you can optimize your expenses, and perhaps cut back to make room for an emergency fund.
Why Not Just Use Credit Cards?
Contrary to what credit card companies would like you to believe, a credit card is not the smartest resource for an emergency fund. Without a plan to pay off the balance, you could be paying exorbitant interest charges and fees over the life of the balance, which could be many years. Having a plan in place now may save you thousands of dollars down the line.
So, How Much Do You Need?
How do you get started and how much should you have in an emergency fund? The answers to those questions depend on your personal financial situation, but here are a few guidelines:
- Setting a target amount for your emergency fund depends on how much you make. A general rule of thumb is that an emergency fund should cover up to six months of your total budget, including living expenses. If that amount seems unattainable, you can start small. The point is to consider how much you make, how much you spend and what you would need if an emergency took some of your income. A financial advisor can help decide a comfortable amount to contribute monthly to build your savings.
- Make sure your emergency fund is separate from your main spending accounts, but still easily accessible. If your emergency fund is tied up in a CD or overseas account, for example, you won’t always be able to access the funds when an emergency occurs. Be sure this account is liquid and that cash can be accessed within two to three days, max.
Still Have Questions?
A financial advisor can help you determine how much you should have in your account, as well as crafty ways on how to get started. For example, if you get an income tax return refund, an emergency fund could be a great place to put it to get a jump start on working toward your goal amount. With your whole financial picture at hand, an advisor can help point out ways to contribute to this account without drastically affecting your day-to-day lifestyle, but while still helping you be prepared for an unexpected financial emergency.
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