Are you wondering why you need an emergency fund? I am sure you’ve heard it many times before, it’s considered one of the most important aspects of successful money management. An emergency fund is where you stash cash so you’re prepared for those unexpected emergencies that life throws at you every now and then. You know, the ones that typically come in groups of three.
Often creating an emergency fund is recommended as a first step to managing your way out of debt. This is because before you can successfully pay off all your debt, you need to stop accumulating more of it. An emergency fund is a means of minimizing your need to use credit (rack up debt) in an emergency.
Why You Need an Emergency Fund
Regardless of where you are financially having an emergency fund is always considered a money management best practice.
Some of the most common uses for an emergency fund are:
- Job loss – so you don’t have to borrow money from mom and dad, or worse yet move back in with them.
- Unexpected home repairs – a leaky roof, a broken window or your furnace, A/C, or refrigerator going on the fritz.
- Medical or dental emergencies. (humans and pets)
- Car problems – a roadside tow, unplanned maintenance like a faulty transmission or engine repair.
- Unplanned travel expenses due to a family crisis.
- Higher than the expected tax bill.
Regardless of the event, an emergency fund is a means of keeping you from using credit. In most cases, the credit will come in the form of credit cards.
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- Why Cash is King
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- Cutting Cable, Saving Money and Getting Comfortable with Feeling Uncomfortable
- Should You Use a 0% Balance Transfer Offer to Pay Off Debt?
- How Many Credit Cards Should You Have? My Credit Score with One Credit Card
- Setting Financial Goals with a Five-Year Plan, The Tiny Tweaks Principle
How Much Cash to Stash?
There are a lot of different viewpoints on how much of a cash reserve you should have, in general, the perspective is three to six months. This perspective is based on the job loss scenario, and how long it will take for you to find a new job. Jobs or careers that are always in high demand like sales positions can typically get by with a minimal cash reserve (three months is the minimum). Jobs in fields that are less prevalent or more technical will probably require a larger emergency fund. Regardless of your situation or perspective, no one will argue the more cash you can stash the better.
When estimating how much of an emergency fund you should have, consider the following monthly expenses.
- Housing – mortgage or rent
- Food and personal expenses
- Health insurance
- Utilities
- Transportation
- Debt payments
Don’t include anything thing that you wouldn’t give up if you experienced a job loss (date night, eating out…), stick to what’s most important. Take your monthly expenses multiply them by three or six months and that’s what you should have in your emergency fund.
3 Reasons – The Real Benefits of Having an Emergency Fund
The obvious benefit of having an emergency fund is that it allows you to forego the use of credit cards or bank loans to pay for emergency expenses. A means of staying out of debt. However, the not so talked about benefits are the ones that impact you emotionally and behaviorally. These are the real reasons why you need an emergency fund.
When you stash cash and have an emergency fund to fall back on you benefit from:
- Reduced stress, and peace of mind – you worry less about an unplanned expense and your ability to pay for them.
- Confidence – the feeling you get when you are in control of your finances.
- Empowered – if you’re not worrying about expenses and debt then guess what, you can focus on other ways to improve your overall financial position. You feel empowered to find more ways to save money or make money.
Having an emergency fund is power. The power to help you successfully manage the unexpected financial events that life can throw at you.
From an FTP perspective, an emergency fund is not an option, it’s a requirement for successful money management. If you’re struggling to establish an emergency fund be sure to read my previous post on how you can build up your emergency fund fast.
Helpful Resources:
- Credit Karma – Free Credit Score, Monitoring & Insights
- Your Money or Your Life, Vicki Robbin Your Money or Your Life: 9 Steps to Transforming Your Relationship with Money and Achieving Financial Independence
- FTP Workbook – Create Your Own Get Out of Debt Plan, Free to FTP Community Members
How many months of cash do you stash? Comment below.
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