Emergency Fund….What is it and Do I Need One?

25 Jan    Blogs

So in the process of truly becoming debt free, it is strongly suggested to have a emergency fund also known as a rainy day fund.  You may be asking what is a emergency fund exactly and why do I need one.  Well, unfortunately we are currently in a financial situation where the possession of a emergency fund would be very beneficial for both personal and business reasons.  The emergency fund would first eliminate the need of going into debt to pay a balance owed that arose due to a emergency of some kind.  No, a credit card is NOT a emergency fund.  A emergency fund is NOT a form of debt in any means.  A emergency fund is a financial safety net; a la insurance, just in case there happens to be a mishap or emergency.  We both know emergencies do happen.  It is a question on when and will you be financially ready to handle it without going into debt.

So now that you have a clear understanding on what a emergency fund is and why you need one, the question is now how much of a fund do I need and where  do I save this money?  First there are a plethora of financial experts that would say anywhere between 3 and 6 months.  But I would say that is definitely not enough, especially after what we are experiencing with the state governments shutting down the local economies and destroying all economic prosperity we were experiencing.  Well being shut down for as long as we have been has been longer than the 3 to 6 months of suggested emergency fund savings.   I strongly recommend 10 to 12 months.  I believe to have a fully funded emergency fund which consists of 10 to 12 months of living expenses (or operating expenses if you are a business), will be more of a cushion.  Even if the emergency is not that serious, it is always best to have more coverage than being under insured.  Remember, your emergency fund is insurance and NOT an investment.  It is there to cover those unexpected bills and expenses that arise like mechanical fixes to your car, a trip to the hospital or a broken pipe at the house.

Now that you have a goal, don’t feel overwhelmed to the amount of money you need to deposit into the emergency fund.  As I am in the process of directing the debt free journey with you here on my posts, you are currently in the process of building your beginning emergency fund.  This is for the purpose to gain momentum and to have something in place during your debt pay off journey.  Further it details on what you should allocate in building your fully funded emergency fund once you have become debt free, besides the mortgage, will be covered in a future post once we get to that step.  The question is now, where do I deposit my money for the emergency fund.  It is strongly recommended that you open up either a liquid money market account or checking account at a credit union that is not at your current financial institution where your checking and savings accounts are at.  You want to keep it separate from your main source of finances, but at the same time have 24 hour access to it.  After all, emergencies can unfortunately happen at any given moment.

Just for a quick example, I am placing the example expenses from the previous posts detailing a sample person’s budget in their attempt to become organized and to being their debt free journey.

The above information details your monthly expenses of $2,463.54.  Take the total month you pay out each month and multiply it by 10.  This will give you your goal amount of $24,635.40.  This would be your minimum amount needed to save to accomplish a fully funded emergency fund.  Now this may seem like a lot of money to save up in addition to keep paying out as you are living.  But, you will be only begin the process of fully funding your emergency fund one you have become debt free with the exception of the mortgage.  The initial step is the beginning emergency fund of only $1,000.00.  So once you have this amount your actual goal is now $23,635.40.  Below is a sample  table of this person’s current debt and the total amount of money being spent each month towards paying back their debt and not paying into their emergency fund or working towards retirement (coming in a later post).

So this person has $85,550.00 in total debt but is paying out $1,190.00 per month towards just keeping their debt accounts current.  Once they are able to finish their debt free journey, they would take the $1,190.00 and now allocate it towards their emergency fund.  This would take them a little over 23 months to achieve a fully funded emergency fund.  But to also mention, this person has additional reoccurring expenses that are not really required, that they could eliminate from their budget by cancelling those services and allocating those funds to their debt.  This would help them become debt free quicker and then fund their emergency fund quicker.  This ends up being up to the choices that you make and how determined you are in ceasing any paybacks to the bank and begin the process of building true wealth and a prosperous retirement.