As tax season wraps up, you are probably wondering what you are going to use that refund on. Many people like to use it to buy extravagant things, but maybe it’s time to make sure you’ve got that emergency fund prepared for a rainy day.
Benjamin Franklin once said, “By failing to prepare, you are preparing to fail.” If this is true, then you must ask yourself, are you preparing your emergency fund or preparing to fail?
What is an Emergency Fund?
To understand what an emergency fund is, it is important to understand what an emergency is – and what it is not. An emergency occurs when you need immediate funds to take care of an urgent matter. This is a situation that you cannot put off until a week or later. You need cash and you need it now! Maybe you lost your job or cannot delay a home or car repair due to the risk of complications. Or maybe you need to pay off a creditor immediately to avoid a collection account. An emergency fund, on the other hand, is not a backup plan for when you want to have a good time with your friends or an extension of your income. Simply put, an emergency fund is a stash of money set aside to cover the financial surprises life throws your way. These unexpected events can be stressful and costly.
Benefits of an Emergency Fun
Forced savings: An emergency fund is a type forced savings. Each month you contribute money until you reach your target amount. Instead of spending, you are saving. This money should be separate from your checking account and any other savings account you may have.
Reduces stress: It is no surprise that when life presents an emergency, it threatens your financial well being and causes stress. If you are living without a safety net, you are living on the financial edge. You may be subconsciously hoping you can get by without facing a crisis. Face it! Emergencies can take you by surprise like an afternoon shower while having the effects of a raging tornado. Being prepared with an emergency fund gives you confidence that you can tackle any of life’s unexpected events without adding money worries to your list.
Reduces bad financial decisions: If you do not have an emergency fund and you are faced with an emergency, you may be forced to rely on credit cards, take out a loan or tap into your retirement fund. Emergencies are never fun to begin with, and the desire to get life back to normal could make you ignore the long-term effects of making bad financial decisions. Emergencies often create a feeling of desperation and it is desperation that opens the door to predatory lenders and high-interest rate credit card offers. Once your emergency passes, you don’t want to be left with high debt and regrets.
Determining an amount
When preparing or modifying a budget the question of financial emergencies is important. It is not always possible for everyone to build a huge emergency fund overnight, but emergencies don’t care if you are not prepared. Many financial experts suggest that you should save at least three to six months worth of your salary. This can provide a safety net in the event you lose your job. A well-funded emergency fund should have enough money to get you by for a few months until you find work again. However, depending on your preferences and income level, the amount can vary. You should first calculate what your living expenses are. Add up how much you spend each month on mortgage or rent, utility bills, groceries and vehicle expenses. You should have at least enough to cover your living expenses for three months. The key is to start saving what you can as soon as you can. A little emergency fund is better than no emergency fund.
There is no harm in hoping for the best while preparing for the worst.
Opening a Savings Account
The best way to avoid spending money is to take it out of sight. Most people look at their checking account as money they have available to spend. But, most savings accounts have a limited amount of withdrawals allowed over a period of time. Knowing you can’t freely spend the money in a savings account helps people save money and pad their emergency fund for a rainy day.
Looking for more great financial advice? Make sure to join us at our next Financial Literacy Workshop Croissants and Credit.