The other day when I was talking with some friends about our current economic situation, one of them mentioned that although they lost their job and their financial situation is stressed, for the time being they have several months of savings in their “emergency fund” to hold them over until things get back on track. Since not everyone has an emergency fund, allow me to share my friend’s thoughts on the importance of having this financial safety net.
First, what is meant by an “emergency fund.” It’s not only having a few extra dollars in the event that the furnace breaks down in the middle of winter and you need a repair — it’s having enough back up to cover you for several months for major events which include:
- Natural disasters
- Sudden job loss
- Unexpected medical expenses
- Extensive property damage and loss
As you know, Hurricane Ian just devastated tens of thousands of homes and businesses in Southwest Florida. When you think about it, a catastrophic loss like a hurricane also encompasses unexpected medical expenses, loss of employment, and destruction of a home and business. It’s basically a triple whammy. For those people who might have between 6-12 months of living expenses in an emergency fund, this can hugely support surviving this level of hardship and getting back on one’s feet. For those who have little to no financial back-up, until the government and/or insurance can help out, it may be necessary to rely on family, friends, and strangers for clothes, a place to sleep and meals. This is not a judgment but only how difficult things can get when our world comes suddenly crashing down. Unfortunately, no matter what happens, certain expenses still need to be paid.
Generally speaking, many financial experts recommend having about nine months of savings in an emergency fund. It can be a good idea to save your emergency fund in a bank account that’s dedicated solely to this purpose. In fact, some experts recommend keeping your emergency fund account at a different bank entirely to avoid the temptation of dipping into it. Certainly, saving cash at home can be risky since the money could be lost, stolen, or destroyed, such as in a fire or hurricane, just the major calamities you’re trying to survive.
How should one start an emergency fund?
Like every other financial plan, start with your budget and determine how much out of each paycheck or other sources of income you can reasonably spare. Maybe it’s only $100 per month but over five years that comes to $6,000. That might not carry you for a very long time but it’s better than nothing, especially when you need access to cash right away.
If you need to have a firmer guideline of how much to save for your emergency fund, consider using the 50-25-15-10 rule. This rule is a way of setting up your monthly budget: 50% of your pay should go to the must-pay needs, 25% can go to reasonable discretionary spending, and 15% should go to reducing debt and 10% to your emergency fund. Of course, you’ll have to adjust the percentages to suit your own personal goals and circumstances.
After making the decision as to how much to save for your emergency fund, make it a carved-in-stone habit to transfer that money to its dedicated savings account as soon as you’re paid or receive the funds. Since interest rates are much better these days, you’ll want the money to grow for you, so consider an interest-bearing savings account with your bank or credit union. You might want to compare banks to pin down the one with the highest annual percentage yield.
It all comes down to the idea of “saving for that rainy day,” in which setting aside sufficient funds for your financial survival is imperative.
Your questions and comments are most welcome (email@example.com).
Nancy Seiverd, President, CMI Credit Mediators, Inc.