An emergency fund is like a life preserver, it can keep you afloat when the unexpected happens and prevent you from moving backward financially. No one likes to think about tragic scenarios they might need to save for, but it’s important to have these funds in place.
This guide can get you started toward building your emergency fund and will help you feel more at-ease. However, it’s a good idea to start a conversation with a trusted financial advisor to review anything you may not have considered.
Why you need an emergency fund
According to Bankrate’s January Financial Security Index, less than four out of ten adults in the United States could absorb the cost of a four-figure car repair or emergency room visit by tapping into savings.
The financial security of Americans is decreasing rapidly, while the cost of living continues to increase. A lot of Americans rely on credit cards or friends and family when the unexpected happens, making situations more complicated and stressful.
There is really no downside to having an emergency fund. It will sit in an account safely and remain stable, or even grow depending on where you put it. If you set up an emergency fund correctly, you won’t feel the need to tap into it for everyday expenses. Instead, you can forget about it and let it grow.
Where to keep it
Your starting point is locating where you’ll designate an emergency fund. Obviously, you should not stash money under a mattress, but you should consider keeping it in an account, like a savings account. The money should be accessible, but able to grow.
Having a separate account minimizes the risk that you would overspend and dip into an emergency fund. It can even be helpful to label your account name “emergency,” so you’re less likely to use it for frivolous purchases.
Layering your fund
Consider layering your emergency fund by having two savings accounts, one regular and one TFSA (tax free savings account). This allows you to have both an aggressive high yield account you’ll have less immediate access to, and an account that is easily accessible but won’t grow as much.
An emergency is not “I don’t have enough money to go out to eat with a friend, let me transfer from my savings.” Rather, an emergency is an event or item loss that affects something central to your transportation, health, and safety. For instance, car repairs, unexpected medical expenses, home damage, and job loss.
It is difficult for some people to know they have a larger sum of money sitting in savings, unable to tap into it. If this is the case, consider budgeting more effectively for splurges so you’re less likely to itch for that coffee and dinner cash out of your emergency fund.
Households should agree on emergency spending to avoid conflict and money-loss. If you live with a spouse or partner, discuss what you foresee as example emergencies, and then write a plan of how to proceed in one of these scenarios. For example, establish which account to withdrawal from first, and create spending limits on specific emergencies. You’d likely be willing to spend more on an ER visit than on a small dent in a car.
So, what’s the damage?
At the minimum, experts recommend keeping three to six months of living expenses stored away and accessible. This may seem high, but there are simple ways to put away cash over time that you can discuss with a trusted financial advisor. Don’t view this as damage or an expense, view it as preventing those.
Ultimately, your emergency fund is for you and any dependents. The amount you should save is what you find comfortable and realistic. Consider the cost of living in your area, your assets, job security, dependents, and medical conditions into your calculations.