An emergency fund, we hear this term constantly, but what is it really? How much should you save? What is it to be used for? Where should the money live? When is an emergency fund no longer your regular savings?
An emergency fund is meant for emergencies ONLY, situations that are life altering. An emergency is not that cute thing at Target or those shoes you MUST have (I’m guilty of this myself). An emergency fund is meant for emergencies. An emergency can look different for your situation but it’s usually the same scenario, a surprise bill, your car breaks down, or you are out of work. Not having savings or an emergency fund can be very expensive because when these incidents happen it’s never at the best time financially.
So let’s get into it. An emergency fund comes after you have built your savings. For some of you, your emergency fund will start off as your savings if you have no savings at all.
Your savings should have a MINIMUM of $1,000. But let’s be real, most people have more than $1,000 situations. But for those of you who have no savings at all, you need at least $1,000 (no shame, just saying). If you have more than $1000, good for you. Aside from the $1000, I will not give you a specific number to have in your savings account. All of us have numbers that we like to see that give us comfort to sleep at night. For some, it’s $5,000, for others it may be $10,000. Whatever your number is save that much. But your savings is just for easy access to cash and to maintain your accounts, this is the savings account connected to your checking account. Your regular savings is not meant to be your emergency fund and it’s not meant to be an investment account. I don’t recommend you keep too much money in this account because you still have things to do with that excess cash! After you reach the number that makes you feel comfortable, next would be bolstering your emergency fund. Your emergency fund needs to be held in a High Yield Savings Account.
How much should you save?
Now, when it comes to emergency funds, I’ve heard 3, 6, 9, and 12 months. Here’s my opinion, 3-6 months used to be the rule of thumb, but I do not think that is enough. I feel as a country we have seen enough incidents where it has taken more than 3 months to find a job, especially depending on where you are in your career. Six months is a good starting point, but I am a millennial and I was released into the world as a college grad in 2008, the height of the recession, where people who had established careers were out of work for months, so I am a bit cautious when it comes to my emergency fund. I think that 9-12 months is more appropriate, it’s not that hard to be out of work for a year for whatever reason. If you are out due to illness, injury, or pregnancy, it can take a long time to recover and the last thing you want to do is rush back to work because you are running out of money. In most, if not all cases 9-12 months should cover unexpected emergencies. Aside from those who lose their job, or suffer from illness or injury; do you know whom an emergency fund of this size could really benefit? Parents, you know so mom and/or dad don’t have to rush back to work right after their baby has been born. Or those of you who are self-employed.
If you still have student loan debt or any debt aside from a mortgage, then I would recommend 3-6 months is a more appropriate amount to save, so that you can focus on paying off your debt. Once that is paid off then you can continue to build your emergency fund to cover up to 12 months.
Ok, now that we have determined the period an emergency fund should cover, let’s determine the amount. When determining the number you need to save, you can use your gross (before tax) or net (after tax) income. If you use your gross income, that would be more conservative.
Take your total gross or net income for the month and multiply that by the number of months you determined for your emergency fund. In this example, we will use 12, because we are fiscally prudent. Your numbers should look like this:
Now now, don’t get overwhelmed, because these are some big numbers, BUT it is possible to save and achieve your other financial goals. The most important part is to make saving a priority. However much you save each month should be a part of your budget, not an afterthought.
For most, it will take time to reach this number so here are a few ways we can reach it.
- Pay off all consumer debt (credit cards, personal loans, etc.)
- Create your general savings account and fund it
- Start saving for your emergency fund. All money that was used to pay off your debt and put into your general savings account can then be funneled into your emergency fund until you reach your goal number. After that, we are investing!
Now some of you may ask how can you invest AND save. Well before you get too hung up on investing in stocks or getting a brokerage account, investing starts with your retirement accounts (these are basically investment accounts, yall, come on!). Invest in your retirement account and GET THE COMPANY MATCH (if it’s available). I cannot stress this enough. This will be how you can continue to invest while you are building your financial foundation. You can’t have true financial success without establishing a strong foundation!