What is the Ideal Size of an Emergency Fund?
This year has been an eye-opener for people all over the world. The COVID-19 pandemic has brought many uncertainties. Many people lost their jobs this year, and many of those who didn’t lose their jobs completely experienced an income reduction. Families that live from hand to mouth have suffered the most due to unemployment. People have learned the importance of having a nest egg to fall back on. So what is the ideal size of an emergency fund and can you “survive” with less than an optimal amount. This article delves into those questions and more.
Even without the pandemic, having emergency funding for your home is important. As you budget for your main expenditures, don’t forget to add something for emergency funding.
What Is an Emergency Fund?
An emergency fund is a stash of money set aside for unexpected events. Not all unexpected events require emergency funding, though. Emergencies are the surprise events in your life that require sudden financial attention. Managing a budget in this climate is already very stressful. However, when planning for your finances, you should put some money away for emergencies. Then, if you are met with sudden financial obligations, you have something set aside to deal with them.
While the ideal size of an emergency fund is subjective on your needs and available resources, it is important to have ready cash in reserve in-case the need arises. Here are several key things you need to know as you begin saving or are looking to reach a new emergency fund goal.
Types of Events That Require Emergency Funding
Most people experience pressing financial burdens every now and then. Some situations are emergencies, while others can wait. As you save for your emergency expenditures, you should have a clear goal on what passes for an emergency, and what is a normal situation. Here are some examples of events that qualify for emergency funding.
Sudden Loss of Income — Most people think that being fired is the cause of job loss. However, this year has taught us that job loss can result from unforeseen circumstances. If you have a stable job, it’s wise to set something aside for emergencies in case you lose the job. If you have a job, an emergency fund should be a top priority. You can lose income temporarily due to different circumstances. You can also experience income loss when you are in between jobs. Natural calamities, such as fires, tornadoes, hurricanes, floods, and pandemics, also contribute to income loss.
Business Is Slow — Unlike people in formal employment, entrepreneurs have high and low seasons. Independent contractors and businesspeople do not claim employment benefits. Therefore, they need to save money to cover unforeseen expenditures. Sometimes, businesses need emergency funds to keep them afloat. Some contracts can experience loss, and you have to cover up the gap.
Medical Emergencies — Most people think about emergencies in terms of medical events. A large percentage of emergency money goes to cover medical emergencies. If you do not have a good health insurance policy, it is very important to set some money aside for medical emergencies. Sometimes, insurance coverage does not pay for all the expenses. People with chronic conditions can max out their deductibles. This is where the emergency fund comes in.
Travel Emergencies — Travel emergencies apply to people who live far away from home. It helps to have a travel emergency fund if traveling back home costs a lot. You may be required to travel home suddenly for family events, medical reasons, or even holidays. Even if you live near home, you can have travel emergencies away from home. However, unplanned traveling for fun does not fall under emergencies. When you have a travel emergency, last-minute booking is expensive. Saving something small over a period of time helps to offset a huge travel bill.
Homeowner Emergencies — Owning your own home comes with overhead expenses. You cannot run to the landlord for help when your HVAC system is not working properly. Imagine the havoc that follows if your HVAC system breaks down. It’s smart to perform routine hvac maintenance. Home emergencies happen when you suddenly need money for something that you cannot live without. If your HVAC system breaks down unexpectedly, you can use your emergency fund to fix it.
Car Trouble — Unexpected car troubles seem to appear at the most inconvenient times. Aside from routine maintenance, your car can incur unexpected costs. Accidents, wear and tear, and damages can put a dent in your pocketbook. Some damages can be covered by car insurance, while some fall on you. If you use your vehicle for work, you should have an emergency fund for unexpected auto trouble.
Loss of a Spouse — No married person wants to think about life without their spouse. You can lose a spouse to death or to divorce. Sometimes, a divorce can cost more than living together. If the lost spouse was the main breadwinner, this will upset the financial balance of the family. You should have a plan in place to protect you from the financial devastation that could result from the loss of your spouse.
How Does Keeping an Emergency Fund Help?
Managing finances is not easy, especially when you do not have enough. When life throws you a surprise expenditure, it threatens your financial stability. Having an emergency fund creates a safety net for you. Therefore, it is essential. When you are prepared for anything, you have confidence that you can tackle life without too much stress. Keeping an emergency fund also stops you from spending all your money on a whim.
You should keep your emergency money away from your daily expenditures account. When you put it in a separate account, you protect it from your usual spending habits. When you budget for all your cash, you assume that the world works how you want it. Emergency funding saves you from sinking into debt. Your overall budget has many parts arranged depending on priority. An emergency fund is an essential part of a solid financial plan.
How Do You Determine the Ideal Size of an Emergency Fund?
People worry about not having enough funding for emergencies. However, having too much money stored away for emergencies is also problematic since it likely isn’t earning much, if any, interest. To determine the proper amount of money to put away, you should consider the following.
Choose a Comfortable Amount — Put away an amount that you can comfortably afford. The idea is to save every month and have enough when emergencies come up. If you push yourself too much and save too much, your other accounts can fall short, and you will fall into debt.
Your Budget — Your budget is determined by your income and your lifestyle. Depending on how much you make, you know how much you can spend. Your lifestyle should be determined by the amount of money you make. You can put a figure on emergencies based on a percentage of how much you spend on everything else.
Your Financial Responsibilities — Your financial obligations also affect your emergencies. You cannot have emergency auto repair funding if you have no car. The larger your financial obligations, the bigger your emergency fund should be. If you are single, your medical emergency fund covers just you. When you add a partner, children, and pets, then the probability for emergencies is higher. Experts recommend that you put away an amount that can sustain you for three to six months if you were to suddenly lose your income. Depending on your income and expenditures, you can set aside an amount that makes financial sense.
Use an Emergency Fund Calculator — Determining the correct size of your emergency fund is a math equation. After you know how much you need to cover your basic living expenses, you can determine how much money you need to survive for three to six months. Depending on your earnings, you can calculate the amount that you need to save each month to set aside the required amount in a certain amount of time. There are many fund calculators available on the internet that will make this process easier for you.
How Do You Build a Lasting Emergency Fund?
Your emergency fund does not stay intact for a long time. Unexpected expenses come up all the time. The secret is to keep a steady growth of the fund, so you do not exhaust it completely. Here are some building blocks for a stable emergency fund.
Stick to a Budget — The secret to sound financial planning is having a reasonable budget. A budget helps you to understand how much you get and how much you give away. When you understand your recurring overheads, you can tell how much you need in an emergency situation. Account for all your money and keep good records.
Sacrifice Within Reason — Saving money calls for self-sacrifice. You may feel the need to splurge and live large in the moment. However, thinking about the future calls for reasonable spending patterns. Do not spend money on things that you do not need. If you love to live large and have fun, account for it in your budget and still have something saved for emergencies.
Plan with Your Family Members — If you live alone, it’s easy to plan for your money. If you have a partner and other dependents, then it gets tricky. Help your partners and dependents understand the budget. Don’t buy expensive high-maintenance toys for your children just because they want them. Cook at home with your partner most of the week to minimize costs from e
ating out. If you can use public transport for work and school instead of buying and maintaining, you will save money. If your spouse has an income, you can help each other contribute to the fund.
Put the Money in a Savings Account — You will always find something to buy when you have money in your main account. You can create a direct debit order on a fixed day of the month. If you have a payday, put up a debit order after the day you get paid. If you are self-employed, put up the debit order based on a certain amount. This helps you save automatically. If you can save the money in an account that earns interest, even better.
Preventing Certain Emergency Expenses
Emergencies are surprise events that find you unprepared. However, some emergency situations can be prevented. Adjust your lifestyle and finances to save you from preventable situations.
Consider moving if you live in a volatile area. If you are buying a home, steer clear of areas where earthquakes, tornadoes, and heavy storms are the norm when possible. If you are a renter, purchasing using renters’ insurance. If theft and burglary are common in your residential area, move away to a more secure place.
Stay within your credit limits. Bankruptcy multiplies the risk of financial emergencies by a large amount. Don’t max out your credit cards every month, and don’t sink into unnecessary debt. Keep track of your expenditures and live within your means. Avoid unnecessary impulse buying on items that you do not need.
Invest in medical and retirement coverage. Health insurance plays a big part in offsetting medical bills. If you are employed, utilize your health benefits. For self-employed people, investing in a good health insurance plan provides a stable cushion for medical emergencies. Having a retirement benefits fund is also very important. Long-term care insurance is another wise investment for everybody who is of working age.
Adjust your lifestyle and live reasonably. Don’t spend over half of your income on rent and eating out. If you want a flashy lifestyle, adjust your income upwards. Avoid friends who encourage you to spend more money on fun. If you can’t or don’t want to use public transportation, choose an efficient vehicle with affordable insurance premiums. You do not need two cars in the family if your workplaces are close to each other.
Establish routine maintenance practices for your property and assets. Your HVAC system will not need an overhaul as often if you schedule routine service at least twice a year. Establish a pattern for routine home maintenance. Repair the worn-out parts in good time to prevent whole systems from breaking down.
Look at your budget and establish some prevention measures that can save you from a financial disaster. Add them to your main budget and follow through with them. You will spend less on prevention than you would fixing a major problem.
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