There are a few principles of good financial health that you’ll often hear: pay off any bad debt you’re carrying, don’t spend more than you earn, and build an emergency fund. In this article, we’ll explain what an emergency fund—or financial buffer—is, why it’s so important, and how to create one.
What’s an emergency fund?
Most personal finance experts suggest that you have an emergency fund of around 3 to 6 months’ worth of living expenses in case something unexpected happens. That might be a family bereavement, a job loss, an economic downturn, an illness, or disability.
Money management experts usually recommend that you pay off any debt (excluding a mortgage) before you start to save, as any money you divert from paying off your debt just means that you’re paying it off longer. However, if you have questions about what the right approach is for your individual case, consider talking to a financial planner.
Why is an emergency fund important?
Let’s say you’ve recently lost your job and have no emergency savings. You’ve got bills coming up and you’re worried that you won’t be able to pay them. You get a job offer for a role that pays less than your previous one and is not in your career plan, but because of financial necessity, you accept it anyway. Not having the money to cover your expenses while you’re not earning an income has now had a very real impact on your career.
If you’d had a financial buffer in this scenario, you wouldn’t have had to accept the first job that came your way. Emergency savings mean you don’t have to panic or make decisions that won’t benefit you in the long run. You can take a little more time to find a new job that will keep you on the right career path and that pays you what you’re worth.
How big should my emergency fund be?
To find out how much money you should aim to save for a financial buffer, calculate your living expenses. If you haven’t already for budgeting purposes, add together all your expenses for a year. These are things like your mortgage or rent payments, clothing, utilities, groceries, school fees, medication, entertainment, childcare fees, transportation costs such as fuel or car payments, and pet expenses. Remember to include annual, quarterly, or infrequent payments like insurance, taxes, haircuts, and so on.
Once you have the total, divide by 12 and calculate what 3 to 6 months looks like for your household. A fully-stocked emergency fund might seem like a daunting amount of money to put aside. In the event of an actual emergency, you’re probably likely to cut down on some luxuries, so you might start with a more basic calculation to cover the absolute necessities of housing, food, utilities, transportation costs, and medication.
If that still feels overwhelming, just aim for a basic amount. To start with, $1,000 might be a good goal. Anything is better than nothing, and when you save that first $1,000, you can make a new, larger goal.
Start saving
Set up a dedicated savings account—preferably somewhere that you can’t easily dip into—and then set up a recurring transfer to come out of your pay as soon as you receive it. Choose a proportion of your income—such as 5% or $100 a month—and stick to it.
When should you use your emergency fund?
There are many circumstances in which you might decide to access your emergency fund. Some of these are:
- taking time out to care for an ill relative
- if you’re laid off
- if you become ill or disabled
- if you need to leave a job quickly before you’ve found another one
- if there is unexpected damage to your home or car
Once you’ve done the hard work of saving, you may be reluctant to touch these funds, but if you’re struggling because of a sudden loss of income, give yourself permission to access it.
What should you do if you’ve used your emergency fund?
As soon as you have a regular income again, put some of it towards rebuilding your emergency fund. Once you’ve reached your comfortable 3- to-6-month mark, you can leave your emergency fund where it is and start saving toward other goals, like vacations, investing, or purchasing or renovating a home. Remember to reevaluate how much you will need in your emergency fund if your financial circumstances change significantly, such as if you have a child or move to a more expensive house or location.
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