Just when it seems like everything is under control, “life happens.” It’s those unexpected, unpredictable emergencies that come up that can put a strain on your finances if you’re not prepared. You may need a sudden house repair, have a loss of employment, need a major car repair, or need to buy a new furnace. The list goes on and on. It is like the All-State Insurance “mayhem” campaign. Something is going to happen. Although you can’t avoid it, having an emergency fund can help you be prepared and take out some of the financial sting.
An emergency fund is a separate savings account that is used to cover unexpected events. This account is to be a safety net and should only be used for emergencies. It shouldn’t be considered as part of your retirement plan or as part of any long-term savings goals, such as education expenses or a new car.
It’s best to have your emergency fund in an interest-bearing savings account at your financial institution that can be easily accessed without taxes or penalties. These funds should not be in mutual funds or stocks for two reasons. First, you are going to need quick access. Secondly, for an emergency fund, you do not want something that may lose in value. Also, you should not have this money in certificates of deposit or IRAs. You don’t want to tap into these accounts because you will incur early-withdrawal penalties.
A common question is how much money you should have in your emergency account. Although it can vary depending on your lifestyle, number of dependents, income, and more, a general rule is that you should have three to six months’ worth of expenses saved. If this seems like it is out of reach, just start by putting a small amount into the emergency fund each week until you get there.
Remember, the goal is to tap into this separate account only when there is an emergency. By having a defined dollar amount, you know how much to save to get there and how much you will need to replenish after you take some out. After you do take some out, immediately start replenishing your account.
It’s not a matter of if “life will happen”; it’s only a matter of when. Start saving and be prepared so that when it does happen, you will have one less thing to stress about.