Monday, July 27, 2009

Create An Emergency Fund

Saving Money Tip #169 - Create An Emergency Fund. In every budget there should be line items for repairs and doctor’s visits. These are regular occurrences that should not be considered emergencies. If you own a house, or a car, or any type of appliance., they will break down. There will be a need for repairs or replacements. If you have children, you should expect to take them to the doctor’s office every so often for illness. It is an inevitable part of childhood. So when making a budget, the items included on it need to be realistic to reflect your lifestyle. Of course there are always emergencies above and beyond what we budget for or expect. An appendicitis isn’t an expected event, while an ear infection in a child should be. Getting your car totaled a week after you bought it probably wouldn’t be in the budget, but repairs from dings and fender benders might be.

So where do we get the money for life’s real emergencies if they are not in our budget? They should be part of our emergency fund. An emergency fund is a set amount of money put aside to handle large, unexpected expenses. Financial experts recommend that people hold 3-6 months’ worth of expenses in an emergency fund. In tough times like today, some recommend having a year’s worth of expenses set aside.

How does one go about setting up an emergency fund? Well, an emergency fund is simply a use for a part of your savings – savings that are dedicated to emergencies. Once you are out of debt and are living within your means, you need to start thinking about saving money for other uses – buying a new for when yours doesn’t work anymore, for retirement when you are not working anymore, for buying a house down the road, if you plan to, or for saving for your child’s college, if you are hoping to help pay for it. Well, an emergency fund is another event you should be saving for. And once its built up you can forget about it. It is money set aside not for a rainy day, necessarily, but for a thundering, lightening, stormy kind of day. You don’t dig into it unless you absolutely have to, and you don’t need to add to it unless you use some of it or if your monthly expenses go up.

For example, suppose you spend $4,000 on a monthly basis for your home, food, clothes, and all of your other expenses. You should try to have a savings account of about $12,000 set aside to pay for your expenses if an emergency comes up or to pay for the emergency itself. If you get suddenly ill and can’t work for a month, then you can dig into your emergency fund to cover your rent and other typical expenses. If you suddenly have to replace a car that wasn’t fully covered by insurance, you can use your emergency fund. By establishing an emergency fund, you are helping yourself stay out of debt by not relying on money that you don’t have to pay for these sudden, unexpected expenses.

If you don’t currently have an emergency fund established, then put it in your budget as a line item so that it gets built up. Once you have the funds set aside (3 months or more) then you can stop savings toward it and put the money in savings for something else. Saving for an emergency fund isn’t fun or sexy, but it will help you stay on your feet when life hands you little surprises.

In Real Life (IRL) – I never really cognizantly saved for an emergency fund. But when I was in my 20s and single, I began putting money away in savings because that’s what I was told I was supposed to do – save for the future. So each month I put money away in either a savings accounts, a money market accounts, CDs, government bonds or mutual funds. About 10 years after college I had saved $90,000 (some of that included gifts from relatives from my childhood and other gifts – I was good at saving but not that good!). Anyway, when I got married and bought a house we used $70,000 as a downpayment on a home in the DC area. I kept the other $20,000 in savings in case we needed to replace things on our old 1950’s house.

That $20,000 has since become our emergency fund. We don’t touch it, but keep it aside for big emergencies that might crop up. For smaller unexpected events, we usually have a buffer in our checking account that we use for things such as a new unexpected air conditioner last year to the tune of $1,900 or a $1,000 repair we had on our car last month. We will dig into the $20,000 if my husband suddenly loses his job and we need to keep up with our mortgage and other expenses or another big life-changing event happens. But for now, we forget about it. In the back of my mind I know it’s there and I’m glad it’s there. So if you don’t have an emergency fund, start saving for one. And then once you have one built up, you can forget about it until an emergency happens. And then you’ll be glad you have it.

1 comment:

Emergency Funds said...

There is a great possibility of unexpected expenses for which you should keep some money as emergency fund. Post is giving great detailed knowledge regarding emergency fund, it will help the people who is having some less idea about it.