What is an emergency fund and why you need them?

Why you need an emergency fund

Why you need an emergency fund

An emergency fund is a stash of money you set aside to cover unexpected financial expenses. If you are unprepared for these emergencies, these expenses can snow ball and become very costly and the related stress will eat you away.

Commonest emergencies for which you need to keep an emergency fund:

  1. Job loss – for you or for your significant other
  2. Family health emergency (medical or dental)
  3. Emergency health care for your beloved pet
  4. Unanticipated car repairs
  5. Unplanned home repairs (emergency plumbing issues, premature appliance breakdown)
  6. Bigger than expected tax bill (can be due to a debt that was forgiven)
  7. Unanticipated travel due to a family or close friend’s tragedy
  8. Unexpected pregnancy
  9. Identity theft
  10. Fire, flood or other unanticipated/uninsured calamities on your household

Studies indicate that a large percentage of Americans are completely unprepared for an unplanned expense. According to a study by FINRA Investor Education Foundation National Financial Capability Study in 2012, 56% of Americans don’t have an emergency fund.

Not having an emergency fund is one of the main reasons by which people get into a debt spiral, turn to payday loans etc.

How much should I have in my emergency fund?

According to Dave Ramsey’s Baby Steps program (step 1.0), you should start with a bare minimum of $1000.00 as your emergency fund.

Then later after you pay down your debt, you need to increase your emergency fund to 3 to 6 months of your monthly expense.

If you are just starting to build your emergency fund or if you are following Dave Ramsey’s program, you can download and use our emergency fund progress chart.

The exact amount of your emergency fund is not dictated by your income. It is dictated by your monthly expense.

If your monthly expense is $5,000, then you will need $30,000 as your emergency fund for enable you to live for 6 months without cutting your lifestyle.

Where should you keep your emergency savings?

You can start with a savings account until you have accumulated about $500.00 to $1000.00. After that you can move the remaining monies to a money market fund with a reputed mutual fund company like Vanguard which is safe and accessible anytime for you independent of any stock market fluctuation.

Benefits of having emergency fund:

Apart from the obvious financial aspect, there are several other benefits of having an emergency fund.
  1. Having a readily accessible pot of money will help you to avail exceptionally good opportunities – such as a neighbor wanting to sell his nice car due to retiring or other reasons. You can offer a price above what the dealership will take it for and have a very nice known car for you to drive for years.
  2. Keep your stress level down which is immensely beneficial from a health perspective.
  3. An emergency fund will help you with general confidence when dealing with emergencies such as job loss, a major car repair, buying a big appliance etc. Having the funds and the ability to pay full in cash, will put you on the drivers seat to negotiate the best possible outcome which otherwise is not possible when you are in a weaker position on the negotiation table.

    For example in a job loss situation you can negotiate for the best severance package when you are not fearful about losing the job itself.

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