Steps to building an emergency fund
The Oh No Fund!
courtesy of Mint.com
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The Oh No Fund!
In almost every general personal finance advice, you will come across the subject of an emergency fund. Emergency fund, quite simply, is the "oh no" fund. It is the "oh no, I broke my leg," or the "oh no, the car engine blew up," and the "oh no, I got fired" fund.
As you can tell, an emergency fund is an amount of money you can use during an emergency. You should be able to access the fund easily (the fund should not take over a week to get access to). You should use the fund only for an emergency. Although simplistic in nature, an emergency fund is an important component for every financially responsible young professional.
Just How Much Should I Hoard Away?
The amount of money you should have in your emergency fund is a variable amount. Experts often recommend at the minimum a savings of three to six month's worth of basic living expenses. On the other hand, many experts also believe that a fund of those size may be hard to accumulate, thus they recommend smaller fixed amount between the ranges of $1,000 to $3,000.
At the end, how much you really need depends on your particular financial situation. The life and expenses of a young professional varies significantly, after all. Some of us may already have a family, while many of us are content being single. Some of us may have a mortgage, while some of us enjoy living in an apartment.
Factors to consider:
- The more people you need to support (besides yourself), the more unexpected expense may occur. Thus, your emergency fund should be larger.
- How easy is it for you to find a new job if you lost your old job? For example, compare the demand for a professional technology Blogger (heh) to that of a nurse. If you're a nurse and you lose your job, you may have little trouble finding a new job within a reasonable time frame.
- As it is with finding a new job, you should also consider your current job security. How stable is your industry? Is your company on the verge of bankruptcy?
To make things easier, besides the factors mentioned above, try a brainstorming session of what may count as emergency to you, and list how much each situation may potentially cost. After you have given some thought to these scenarios, you should have a better understand of how much you may need in case of an emergency.
Steps to Building an Emergency Fund
- Set an amount that you're comfortable with. If you know for sure you can't accumulate three to six month's worth of basic living expenses (that is food, lodging, transportation, etc.), try the smaller ranges of $1,000 to $3,000.
- Start saving right away. Any amount will do. After you've met your basic living expenses, you should put away any extra money towards an emergency fund.
- Having difficulty finding spare change to save for an emergency fund? Try cutting down on your expenses temporarily. Skipping that weekend where you treat your buddies out, or withholding yourself from premium cable for a few months can quickly add up to sizable amounts. You can always tack these expenses back on after you've built your emergency fund. You may also find out that you're perfectly okay without these luxuries.
- Paid off a recent bill? Keep paying the same amount, but this time, pay it to yourself.
- A nice fat tax return? No, it's not vacation time. If you don't have an emergency fund, this would be a great boost to building one.
- Keep the funds in a liquid account (how fast it can be converted to cash), such as a checking account, saving account, money market account, and maybe even Certificate of Deposit (although there may be penalties to early withdrawals). For those comfortable with Internet banking, try the many high-yield online savings accounts, such as ING Direct or HSBC Direct. Wherever you choose, avoid an account with fees that may actually diminish your emergency fund in the long term.
- Don't keep it where you can spend it easily. This is not an issue if you're a disciplined person, but for some, keeping it liquid also means that it can be spent easier. If you're unsure of your discipline in leaving the emergency fund alone, what you can do is open a checking/savings at a separate bank. Basically, give yourself some barriers to think twice before you cash the fund.
- Once you've met your emergency fund goal, move on to other financial goals. Now you can worry about other goodies such as saving and investing for retirement and saving for your children's education.
- Reexamine your emergency fund's size periodically, especially during life changing events. Finally got hitched? Got a kid? Landed a hot new job? Reexamine your fund's size to see how well it correlates to your current situation in life, perhaps it may be time to put a little bit more in.
Break (Only) in Case of Emergency
Remember that an emergency fund is for an emergency only. Understand that it is a necessary part of a sound financial budget. Without an emergency fund, you may expose yourself to unmanageable debts. Would you like to pay for your loans, bills, on credit cards only?
For those that have met some unexpected turns in their financial life, they are well aware of the importance of an emergency fund. Get one started now, so you will have some financial cushion to fall back on when you unexpectedly have to yell "oh no!" one day.
How much should I spend every month? Where is all my money going? Which credit card is the best for how I spend? These questions and more are answered at mint.com Mint is building a free, simple, and secure personal finance web-app. Designed to be effortless, Mint consolidates your financial life in one place. See where your money goes and know when your bills are due. Patent pending algorithms even show you personalized ways to save and make more money. If your finances could use organization without effort, Mint is for you.
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