What stands between your family and major financial trouble?
Hopefully, it’s not just a credit card or a home equity line.
In many cases, married couples have only a small cushion (if there’s a cushion at all) to carry their family in the event of a loss of income or a major expense.
Once you’ve taken care of any nasty consumer debt, it’s time to prepare for those inevitable rocky times that lay ahead. After you get an emergency fund in place, you’ll be ready to face those costly home repairs, unexpected medical bills and periods of unemployment.
You won’t like it when an emergency strikes, but you’ll be prepared and ready to cover the financial impacts without resorting to debt. Let’s build a full emergency fund!
How Much Should We Save?
As a general rule, most families should have approximately 3-6 months worth of expenses in an emergency fund. It’s important to understand that this not 3-6 months of income, and it’s not inclusive of all the money you spend in a typical, non-emergency month.
To calculate an appropriate amount, go through your budget and decide on a line-by-line basis whether each expense is something that you’d need to cover if you were faced with unemployment. Once you have that monthly “bare-bones budget” amount, multiply it by a factor of 3-6 and you have your goal.
The 3-6 month time-frame will allow most people to regain meaningful employment if they are faced with a job loss. While unemployment isn’t the only potential emergency out there, it’s certainly a relevant threat for most people and this amount of savings will also cover most reasonable “expense” emergencies that you may face.
So, should you save 3 months, 6 months or something in between? Well, your personal amount should be based on your exposure to risk as well as your risk tolerance.
If you have two stable jobs and a fairly “calm” life with little volatility in your expenses, then 3 months is probably sufficient as long as that amount makes you comfortable. On the other hand, if you are a one-income family with lots of little kids around and you feel like trouble is always lurking, you should shoot for 6 months of expenses. At the end of the day, it’s a judgment call.
Where Should We Save It?
While I recommend that a small portion of your emergency fund (around $1,000) should be kept close to home at a local bank for super-fast access, most of your fund should be allowed to work a little harder for you. In most cases, we’re talking about many thousands of dollars (often tens of thousands), and there is decent money to be made through interest earnings.
Just to be clear, you should not be investing this money and putting it in any real risk. Your emergency fund is effectively an insurance policy you’re keeping between yourself and financial ruin. There is certainly a place for investing, but we will not be using our emergency fund for those efforts.
That said, there are options out there that pay better rates than your local bank, offer reasonably fast access to your money and keep it safe. My personal favorite is an ING Direct Savings Account. ING is a great company who pays strong, market interest rates on your money while keeping it FDIC insured and very accessible. Do a little research and find the best solution for your family.
When Should We Use It & What Happens If We Do?
Once you have a nice emergency fund stashed away, you may wonder just when you are supposed to take money out of it. Well, you don’t want to tap into your emergency money unless you have an actual emergency that you couldn’t foresee.
For example, regular home maintenance should be part of your budget and not something you need to take from your emergency fund to pay for. And you know your car insurance is due each year, so that’s not a good use of these funds. On the other hand, you can’t plan for a broken leg or a job loss, so when you have a true emergency, tap into your account and feel good that you are prepared.
Once you get your full emergency fund in place, you’ll probably want to move onto investing, paying off your mortgage and meeting some other financial goals. If (or when) you do encounter trouble and you have to take money from your account, you’ll need to pause these other goals temporarily and redirect your “extra” money each month back into building your emergency fund until it’s back to your comfortable level.
Without question, this full emergency fund requires a lot of money to complete, but if you keep the same intensity that took you through paying off your debts and redirect that “debt snowball” money each month to your savings, you can absolutely do this.
Once we completed this step, my wife and I felt a true sense of financial peace in our family. We’ve needed it several times and, although spending lots of unexpected money is never fun, it’s great to know that you are financially ready to face most of the nasty stuff that life will throw your way!
Bring peace to your marriage by building your own full emergency fund.