Picture this: Your car windshield cracks, or your dog eats a sock, or you have a medical emergency that isn’t covered by insurance. You don’t have the financial reserves to cover it, so you charge it to your credit card. Now you have that initial expense plus interest to repay, starting a cycle of credit card debt.
Is there anything less hyggelig than that?
Though emergencies themselves come as a surprise, the fact that an emergency will come up at some time in your life is a guarantee. That’s just a part of living and being an adult. What doesn’t have to be guaranteed is the financial stress that comes up around unplanned expenses.
An emergency fund, as the name implies, is to be used for just that: an emergency. They can go by a lot of different names. Some of my favorites are a Rainy Day Fund, an Oh Sh*t Fund, and a F*ck You Fund (pardon my French, but, to be fair, emergencies tend to spark words like that).
Emergency funds are meant to cover a financial shock without using your credit card, taking out a personal loan, or withdrawing from other accounts, such as a retirement account, to cover it. However, 58% of adults in the US report feeling uncomfortable with the amount of money in their emergency fund, and 23% of adults in the United States have no emergency savings at all.
Emergency funds also give you freedom: freedom to leave a toxic work environment, freedom to aggressively pay off debt and meet other savings goals, and freedom in the form of peace of mind.
So, since we know that emergencies do and will occur, what’s the best way to prepare? Like everything in your financial life, the best way to prepare for an emergency is to set a clear goal and have a plan to get there!
Step #1: Decide on an emergency fund goal amount
The first thing to do is determine how much your emergency fund goal amount will be. Most experts recommend saving between 3-6 months worth of expenses, but some people might feel safer saving up to 12 months.
The important word here is expenses, not 3-12 months worth of income! Start by calculating your monthly essential expenses, such as housing, groceries, transportation, and minimum monthly debt payments. This is your Bare Bones Budget, which is the minimum amount you need to keep yourself clothed, housed, and fed each month. Because your Bare Bones Budget just consists of essential expenses, it wouldn’t include spending on things like entertainment, savings goals, or charitable giving, even though your normal monthly budget might include line items for those things.
Next, multiply that Bare Bones Budget by both 3 and 12, and that will give you the range of how much you’ll need to save for your emergency fund. Now, that is a pretty big range! For some, having 3-4 months worth of expenses saved will be plenty, but others may need closer to 12 months worth.
Here are a few questions to ask yourself to determine what your personal goal amount should be:
How stable is my income? Freelancers, artists, gig-economy workers, or seasonal workers may have more variance in their income streams, therefore may want a bigger emergency fund.
Is there a chance that I might be without work for more than a few months at a time?
What types of emergencies have I dealt with in the past? How much did those cost?
What number would make me feel safe?
If you’re starting at $0 for your emergency fund, whatever your personal goal is will most likely feel like a very big number! Maybe so big that you just decide to not go for it at all, particularly if you have very little money available to put towards this goal each month. But, like any long term goal, remember that it will take time to achieve--it won't happen overnight!
There also might be ebbs and flows while you build up your emergency fund; maybe you save $1500 and then have an emergency that costs $600. That’s okay! If you have an emergency that requires you to dip into your emergency fund, readjust your budget for a few months to make replenishing your emergency fund a priority, and once you’re back on track you can reprioritize other savings goals again.
Remember, you are building up your emergency fund to cover emergencies, so if one occurs while you’re building that fund, pat yourself on the back for having an emergency fund to begin with, use that money to cover the expense, and then work on rebuilding your fund.
Step #2: Make a plan to reach your goal
It could take a while to reach your end goal, depending on how much extra money you can set aside each month, how steady your income is, and if emergency expenses come up along the way. That’s okay! Practice paying yourself first each month, make saving a habit, and set mini goals to ensure you’re making consistent progress towards your end goal.
According to a 2022 study by Bankrate, 56% Americans are unable to cover an unplanned $1000 expense. So, let’s start with $1000 as the first mini-goal!
The first step is to figure out how and when you’re going to get there.
If your first mini goal is to save $1000 in a separate account just for your emergency fund, and let’s say you would like to save that amount in four months.
$1000 ÷ 4 months = $250 per month
Or, maybe you know that you can save $25 per week towards your goal.
$1000 ÷ $25/week = 40 weeks, or 10 months
Now that you have your goal amount and goal date, include the amount that you will be putting into your emergency fund in your spending plan like any other monthly expense.
Here are some additional mini goal ideas:
Save $500
Save $1000
Save 1 month worth of expenses
Save 3 months worth of expenses
Etc., etc... you get the picture!
Remember, it’s okay to readjust your goals along your saving journey! Make saving at least $1000 a priority. Continue making progress towards your end goal, but if you need to readjust your plan to make progress towards other financial goals as well, such as tackling debt payments, that’s okay! You don’t have to put all other financial goals on pause until you have a fully funded emergency fund, as long as you have a clear plan to get there.
Step #3: Decide where to house your emergency fund
Your emergency fund should be in its own account, separate from an account where you pay your bills or are putting aside money for a separate savings goal. It can even be a good idea to open an account at a separate bank or credit union from where you have your checking account, so it’s not as tempting to spend or as easy to transfer between accounts.
The most important aspect of an emergency fund is that it is liquid and safe. It should be easy to withdraw money from your emergency fund if you need it, and your emergency fund is not money to take financial risks with.
Some good places to store your emergency savings are:
High Yield Savings Account (HYSA)
Money Market Deposit Account
A separate savings account at your current bank or credit union
Some places to NOT store your emergency fund are:
Within your current checking account
Invested in the stock market
Under your mattress (or in your underwear drawer, buried in your backyard, etc. etc.)
Step #4: Set some spending boundaries
Emergency funds are to be used to pay for expenses that are unplanned and necessary, such as major car repairs, medical bills, or temporarily cover living expenses after a loss or reduction of income.
An emergency fund is not for periodic, predictable expenses, such as routine car maintenance, gifts for the holidays, or taxes. It’s also not for expenses that are unnecessary, like vacation spending, or for a separate financial goal, like a house downpayment.
An emergency fund is the financial goal, and is meant to be sitting there, ready to use, if an emergency arises.
How will you use your emergency fund, once you have it? What constitutes an emergency? Here are some questions to ask yourself to determine whether or not to withdraw money from your emergency fund.
1. Is this a necessary expense?
If it’s a want and the only way to afford it is to draw from your emergency fund, then it can wait, pure and simple. By all means, make a plan for how you’re going to save up for that vacation, or that new furniture, or a new phone! But your emergency fund is not the place to find that money.
2. Is this an urgent expense?
I don’t know of many emergencies that aren’t urgent; generally, emergencies come as a surprise and need to be dealt with immediately. However, if you have an expense that you know will be coming up, then use that advance notice to look at your budget and make a plan for covering it besides dipping into your emergency fund.
3. Can I pay for this without withdrawing from my emergency fund?
Just because something is an emergency doesn’t mean you have to use your emergency fund! Maybe you have an unexpected trip to the vet or a surprise car repair, but you can make an adjustment in your monthly budget to partially or totally cover it. Your emergency fund is there as a back-up, but if your budget can absorb that unexpected cost without it, all the better!
On the other end of the spectrum though, sometimes withdrawing money from your emergency fund is so scary and paralyzing that you’d rather charge the expense on your credit card and pay it off slowly rather than watch your emergency fund balance decrease (ah-hem... I may have been guilty of this myself). Your emergency fund is there as a buffer, to protect you from getting into debt and keep you financially secure! Going into debt when you had the money to pay for it kinda defeats the purpose of having an emergency fund.
Hopefully these guidelines and ideas will help you along the way to creating and fully funding your Emergency Fund/ Rainy Day Fund/ Oh Sh*t Fund/ F*ck You Fund!
If you need help meeting your financial goals, schedule a FREE initial 15-minute call to discuss what financial coaching is, what your goals are, and see if we would make a good coach/client team!
Sources:
Bennett, Karen. “Survey: Less than Half of Americans Have Savings to Cover a $1,000 Surprise Expense.” Bankrate, 19 Jan. 2022, https://www.bankrate.com/banking/savings/financial-security-january-2022/.
Bennett, Karen. “Survey: Majority of US Households Uneasy with Level of Emergency Savings.” Bankrate, 23 June 2022, https://www.bankrate.com/banking/savings/financial-security-emergency-savings-june-2022/.
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