Have you’ve heard of a rainy day fund or an emergency fund? Do you wonder what these “funds” might be?
Well, they are both terms to describe the same thing. Money to be used for when the unexpected happens.
OK…What does that actually mean and why do you need to care? Great question! Over the next 5 minutes, you will be introduced to what an Emergency fund is and how to setup one up.
What is an Emergency fund?
To put it simply, life doesn’t always go according to plan. When it doesn’t, you may need some cash…and you may need it quickly.
Let’s say you live in the Northeast like I do, and lets say a hurricane comes rolling through your town and causes havoc to both homes and local businesses. Once the storm passes, you might notice a lot of damage to your house which needs to be repaired as soon as possible in order to prevent further damage. Insurance should cover this…at least you hope they will. If you have ever put in a home owners insurance claim during a non-mass damage event, you will acknowledge that getting an adjuster to your house is, how shall i put this…less than quick. Now imagine how long getting an adjuster to your home will take immediately following a storm.
So you have damage to your house and you need to make repairs to your house and make them quickly, but you cannot wait for insurance. How do you pay for these repairs? Credit cards are a quick and convenient way to pay. What if the contractor doesn’t accept credit cards or says that if you aren’t paying with cash, the wait time for repairs is a few weeks.
Well, this is exactly what an Emergency fund is designed to help with. An Emergency fund is simply a savings account dedicated to be used for unexpected expenses. These expenses could be repairs to a home, unforeseen medical expenses or to help pay your bills in the event you or your spouse lose a job.
How do you setup an Emergency fund?
If you haven’t already, I recommend starting an Emergency fund as soon as possible. These are relatively easy to setup and regular contributions can be automated!
At a very high level, you will need to do the following;
- Figure out how much money do you need to cover one month of expenses
- Open a savings account
- Automate monthly contributions to the Emergency fund
Determine how much savings you actually need
Most financial planners will say you will need to save 6 months of your monthly expenses. What I recommend is starting out small. Aim to save 1 month worth of expenses.
How do I calculate what is needed for a month of expenses?
Well, if you’ve read my article on creating a spending plan, then this answer is super simple. Even if you haven’t read that article or don’t have a spending plan, you can use the following template to help determine what you will need to account for. Keep in mind, these are totally made up numbers, your actual expenses will vary.
- Child care (daycare, school, baby sitter, etc)
- Car payment(s)
- Utility bills
- Student loans
- Personal loan payments,
- Credit card (minimum payment only)
- Any other essential monthly expense
You will notice i didn’t include any subscriptions, memberships or non-essential bills. In the event you may need to tap into Emergency savings, you should consider suspending or cancelling all non-essential spending.
Based on the example above, we need $3,860 to cover all necessary monthly expenses for 1 month. For 3 months, we need $11,580 and for 6 months we need $23,160. I know this may seem like a unattainable amount of money. However, any and everything helps when it comes to being able to provide for yourself and family during an emergency.
Now don’t stop there, make a goal to reach 6 months of expenses in the Emergency fund.
Open a savings account
Opening a savings account is a really easy and can be done completely online. I recommend opening a savings account from a bank that has a branch within 5 miles of your home. Remember, when you need to tap these funds, you want the local branch to be as close as possible.
Please keep in mind that this savings account should only be used as an Emergency fund and not your general all purpose savings account.
Setup Automatic contributions to your Emergency fund
Set it and forget it! Automating contributions to your emergency fund is my recommendation. Now, if you want extra credit, automate contributions on the day your paycheck is deposited into your checking account is what I would suggest.
By setting up automated contributions or transfers to the emergency fund, you take yourself out of the equation of needing to remember to add money each month. You will never need to remember to move money over or worry that you don’t have anything left over in your checking account at the end of the month.
I’ve set up automated contributions with several banks and the process is relatively straight forward. Essentially you want to setup a reoccurring transfer from your checking account to the emergency fund on the day your paycheck is deposited. If you are paid on the 1st and the 15th of the month or every other friday, most banks online platform help make this easy to do.
If you get stuck, give the bank a call and they should be able to walk you through this.
Keeping tabs and adjust as needed
If you’ve followed along and have setup an emergency fund with automatic contributions, great work!
Once you’ve saved up enough to cover a month of expenses, stop, pat yourself on the back and realize that you’ve just accomplished something what most Americans have never done. No joke. Over 50% of Americans polled have stated they live paycheck to paycheck. With one month of savings in the bank for emergencies, in the event that you do need some cash, you have a lot more flexibility and security for your family.
Lastly, I recommend that you check in on your progress every 6 months or whenever your income changes, whichever comes sooner. Life changes all the time and you should keep your contributions up to date whenever your income or expenses change.