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Importance of an Emergency Fund

Along with making goals, creating a budget, and managing debt, it is very important to establish and maintain an emergency fund. Most people at some point in their life, have heard from their grandmother or some other person “save it for a rainy day.” This may seem cliché because it is said very frequently, however, in the world of finance and money management, there is a 100% chance, at some given time in life, it will rain. By having an established emergency fund you can save yourself a lot of pain and hardship when faced with a financial or life emergency.

Getting Started

The first step in establishing an emergency fund is calculation and saving. Many experts agree that a well-established emergency fund should be between three to six months living expenses. This is because many financial emergencies involve loss of income in some form. By having three to six months saved, this will give you ample time to find a new source of income while still paying all of the bills you may normally have to. Similar to budgeting you must calculate your monthly living expenses including mortgage or rent, vehicle or other loan payments, utility bills, groceries, gas, or other expenses essential to living month to month. Once you know the amount you will need monthly you can multiply it by three to six and start saving. This money needs to be somewhere safe but it must also be liquid, meaning it can be converted to cash quickly should you have an emergency and need it. Saving accounts are safe, however, once you begin to have a bigger savings you may want to think about putting that money where it has a better chance of making money through interest such as a money market account or a short-term certificate of deposit (CD).

It Takes Time

Your emergency fund does not need to be established overnight; in fact, it is very unrealistic to establish one overnight. Although, if you have the ability to establish one overnight, such as an inheritance or bonus, it is important to put that money away in savings and do not look back. If you have a hard time putting away or saving money, do not be afraid to start smaller and work up to a larger amount. Start with $10 per month, or per paycheck, and do this for a couple months. It will not be a lot of money, but you will develop a habit and eventually will not miss the $10 you have been putting away. Once this happens you can think about bumping the number up to $15 or $20. These small numbers will eventually turn into big numbers as long as you keep working hard toward reaching your goals.  You can set up automatic transfers or direct deposit so that the money is put aside before you even see it!  Remember:  always pay yourself first.

Emergency Means Emergency!

It is important to remember why you have this emergency fund and define what it should be used for. There will be times when it is tempting to use this money for expenses such as vacation, down-payments, going shopping for seasonal clothing, getting a new game system, paying down other debts, or other things along those lines, but try to abstain from this activity. Your emergency fund is for financial emergencies, which can come in many forms.:  you can make a list of acceptable emergencies and only use the money on the things on that list. Everyone’s list will look a little different, however, here are some of the common things emergency funds may be used for: unemployment expenses, medical emergencies, unexpected repairs such as vehicle or household (due to unforeseen causes), unexpected tax bills, emergency veterinary bills, to name a few. It is important to remember the purpose of this account is to keep you from adding debt as a result of trying to come up with money quickly. Plan for worst case scenario so when smaller emergencies arise they are easily covered.

Revise and Maintain

It is essential you maintain your emergency account. There will be times you draw money from the account because emergencies happen, but remember that the money you use on emergencies is money that can no longer be used on other emergencies. This goes back to starting small, if it has been a while since you have contributed a portion of your paycheck to saving, you may have to go back to saving $10-$20 per paycheck until you get your emergency fund balance replenished. You will also have to reevaluate your emergency fund throughout life to adjust to life changes such as marriage, children, etc. Choosing a number that will give you three to six months of living straight out of college could be significantly smaller than three to six months of living expenses when you are married with children. If in doubt, save more.

This concludes the Financial Literacy Month series on money management.  Look for other posts for more tips on both saving and spending money wisely.

Resources

http://financialplan.about.com/od/savingmoney/a/emergencyfund.htm

http://www.investopedia.com/financial-edge/0812/why-an-emergency-fund-is-important.aspx

 

Shannon Vaughan
Peer Counselor I
Powercat Financial Counseling
www.k-state.edu/pfc

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