Unexpected financial expenses seem to crop up at the least opportune time. The car needs a new transmission, you lose your job, or a parent or child becomes ill and you need to reduce your hours at work in order to care for them, taking an unexpected reduction in income. All of these expenses, and others, can drain savings quickly.
Why have an emergency fund?
You can resort to using credit cards to pay for emergency expenses however, worrying about paying down your growing credit card balance can lead to further stress during an already difficult period. You will experience “one step forward and two steps back” where it’s hard to see any progress.
How to create an emergency fund.
The better choice is to establish an emergency fund now. Determine how much money you want to set aside in the emergency fund and set up an automatic deposit into that account once a month for a small amount, so that you establish the habit of adding to the emergency fund. If you have finished paying off a monthly loan of some kind, consider immediately setting that money aside for the emergency fund so you don’t use it for daily expenses. Set up an account with your bank that is not easily accessible so there is less temptation to use the money.
Remember a large screen TV or a vacation is not an emergency. If large items such as these, are on your wish list, start saving for them separately and only use your emergency fund for true emergencies.
How much should you have in an emergency fund?
The rule of thumb is to keep six to twelve months of living expenses in savings for emergency funds.
Whereas a dual income family could get away with six months of income in savings, if you are a single income household, you would want twelve months of income saved.
If you and your spouse work for the same company, there is a greater risk of you both losing your jobs at the same time, therefore it would make sense to keep twelve months.
Having an emergency fund will reduce your stress during periods of difficulty because you can tackle the situation and not worry about the financial aspect.