You’ve established your rainy day fund and it’s on its way to being properly funded. Now you’re hooked on the savings machine and you want to build a more financially secure future. Great! The most important thing to save for after your rainy day fund is your emergency fund.
We’re glad you asked! An emergency fund is extremely important – from both a short- and long-term financial planning perspective. The purpose of an emergency fund is to cover emergency expenses – such as loss of a job, major household repairs, major illness, or other medical emergencies.
Everyone needs an emergency fund. In 2018, 1 out of every 3 people dealt with a major, unexpected financial emergency. However, not everyone is financially prepared to deal with them. Unfortunately only 37 to 41% of Americans have sufficient savings to deal with a major unexpected financial expense. Starting to build your emergency fund now means that you’re prepared should an emergency hit you.
Ideally your rainy day fund and your emergency fund live in separate accounts. It’s much easier to track how you’re doing on individual goals when the funds are not comingled. Given that you are starting out and the balances may be low, it’s incredibly important to make sure that wherever you decide to open the accounts that you are not being charged fees for the low initial account balances.
A lack of an emergency fund is a severe hindrance to both short-term and long-term savings goals. Without an emergency fund, when unexpected expenses come up many people turn to credit cards, personal loans, or loans from friends or family. Borrowing the money typically entails added interest, which can substantially increase the total eventual cost of the emergency expense.
From a short-term goals perspective, the interest accrued on borrowed money can add an increased layer of difficulty. As the debt owed grows over time, it becomes more difficult to pay off the debt, maintain financial solvency, and attempt to set aside additional funds for savings purposes. This difficulty in achieving short-term financial goals can have a profoundly negative affect on an individual’s long-term savings goals.
Generally, it is best to have three to six months’ worth of expenses set aside for emergencies. Depending on your personal circumstances, you may wish to have more set aside. Once you have established the ideal amount for your emergency fund, develop a plan for setting aside a certain amount into it on a regular basis.
Analyze your expenses and figure out what you’re truly spending on a monthly basis. Look at credit cards and direct debits from your accounts. Figure out what expenses are absolutely mandatory and that you would have to pay if you were to find yourself suddenly out of work, such as living expenses, auto payments, and grocery bills. If it’s helpful, make a list of all expenses and figure out which ones you would cut the quickest.
Rather than letting an emergency expense sneak up on you, work on developing (and implementing) a savings plan to protect you from unexpected expenses. Your savings plan should include both short- and long-term financial goals that are practical and achievable.
Having an emergency fund will benefit you by giving you peace of mind when it comes to the knowledge that you are well-able to handle a potential financial emergency. If an unexpected expense does come up, you’ll be able to deal with it without having to borrow the money or cut down on other expenses. This will empower you to meet both your short-term and long-term financial goals, which will put you on a solid path to healthy financial future.