In weather and in life, rainy days are inevitable. From natural disasters and economic hardship to car repairs and medical bills, the unexpected happens, and it can be expensive. Insurance coverage, support networks and government aid are important safety nets, but they aren’t always enough. That’s why experts recommend having an emergency fund to prepare for a rainy day.
Why you need an emergency fund
An emergency fund is money you set aside to help you weather an unexpected financial emergency such as loss of income or major expenses. These emergencies may include unemployment, medical bills, home or vehicle repairs and more. A good emergency fund can provide three important benefits during a financial emergency:
- Helps cover crucial expenses such as health care, housing, transportation and basic necessities (example: paying to fix a vehicle that needs an expensive repair)
- Avoids the need to incur secondary expenses such as fees, interest, tax penalties and opportunity costs (example: not having to borrow money or dip into retirement savings during a period of unemployment)
- Reduces stress and anxiety relating to a financial emergency (example: not worrying how to pay for a trip to the emergency room)
When to start building your fund
If you can afford to set some money aside, you’re probably ready to establish an emergency fund. Don’t worry about your fund just yet if you’re currently in the middle of a financial emergency, if you have high-interest debt or if you’re struggling to pay bills. Those urgent priorities should often be resolved first before you look to the future and start building your emergency fund.
How much to keep in your fund
One of the toughest decisions to make for your emergency fund is how much money to keep in it. Many experts recommend setting aside three to six months’ worth of expenses. Since the future is unknown, it’s impossible to know which exact amount is right for your fund, but your personal situation will determine whether you should lean toward a larger or smaller amount.
Here are some important factors to consider when deciding on the size of your fund:
- Size of financial safety nets (insurance coverage, family assistance, etc.)
- Number of dependents (individuals requiring financial support)
- Level of job and income stability
- Amount of property and liabilities (homes, vehicles, etc.)
Where to keep your fund
It’s critical that your emergency fund’s balance be safe and quickly accessible. That means keeping it away from risk such as the stock market and keeping it in a liquid form such as a bank account. An FDIC-insured checking or savings account generally provides the best protection and access to your money. If you’d prefer that your emergency fund earn a bit of interest, you can consider locally and nationally available high-interest bank accounts.
When to use your fund
Your emergency fund can be used for any necessity that you can’t pay for without taking on high-interest debt (e.g. credit cards) or dipping into your long-term savings. When such an emergency arises, don’t be shy about using your fund. That’s what it’s there for! Use the money where it’s needed, then build your fund back up once the hardship has passed. Resist the temptation to raid your emergency fund for unnecessary purchases, and remember to include inevitable expenses such as home and vehicle maintenance in your regular budget.
Building an emergency fund isn’t always easy. It can take months or years of discipline to do so, and you may not see a dramatic payoff any day soon. However, you’ll gain important peace of mind in the meantime, and when a rainy day does come your way, you’ll be very glad you prepared.
Draper and Kramer Mortgage Corp. does not offer tax or financial planning advice. Please contact your tax and financial planning professionals for any questions relating to these issues.