An important step to FIRE is building an emergency fund to protect yourself from unexpected expenses, or even to just give you peace of mind. Emergencies are inevitably going to occur, make sure you’re planning for that rainy day.
The basic definition: Cash set aside for emergencies
Why Do I Need an Emergency Fund?
The last thing you want to have to do is be forced to take out a loan, put your expense on a credit card or ask friends and family to borrow money. If a sizable emergency comes up when you don’t have an emergency fund, it could lead you into a world of debt.
If the mountain piles too high, you may be spiral into financial turmoil for years, or even worse, be forced to file bankruptcy. This will destroy your financial plans for years or even decades.
There are an infinite number of reasons you need to set-up an emergency fund, but we’re going to cover the most common ones.
- Medical Emergency
- Loss of employment
- Home Repair
- Car Repairs
- Sudden death in the family
- Insurance Deductible
- Tax Bill
- Natural Disaster
How Much Money Do I Need?
The answer to this question vastly depends on your own situation. If you’re just starting to pay off debt, we recommend a minimum of one month’s worth of living expenses (non-discretionary) especially if you own a home. If you’ve completely paid off all of your debt we recommend a minimum of three to six month’s worth of living expenses.
Anything beyond that is your own personal decision and based on your comfort level. If you know you have a stable job, maybe three months is comfortable for you. If you have unsteady income, or are self employed, consider six or more months of living expenses saved.
Ultimately the correct answer is: Do what allows you to sleep well at night without putting yourself in a risky situation.
How Do I Start Saving?
Understand your current risk tolerance. Do you have a steady job? Do you have any debts? Who relies on your income?
Determine your ideal/goal amount to have saved. Consider removing all of your want items from your budget, keeping only the need items to project how much you would need to stay afloat each month.
Make it a line item in your budget. This step is so important, be intentional. Don’t just allocate “whatever’s left at the end of the month”, Pay yourself first!
Track your progress towards your goal. We have a free emergency fund tracker you can print out to track your progress along the way, click here to grab a copy!
Celebrate! Maybe enjoy a nice dinner out on the town to reward yourself for all of your hard work, within reason.
Where Should I Keep My Emergency Fund?
The best place to keep your emergency fund is somewhere accessible. That means not in an investment account. You want the money to be quickly and easily accessed in the event you have a true need for your emergency funds.
Consider utilizing a high yield savings account, a premium yield account at a local bank or credit union, or a money market account.
When Shouldn't I Touch My Emergency Fund?
Unfortunately, many people have misconceptions on what a true emergency is.
Needing new tires because you drove 40,000 miles with your old set, is NOT an emergency. You should be planning ahead within your budget for that situation.
An expense that should’ve been a sinking fund is never an emergency. Seeing a fancy new TV on sale for 50% off is also NOT a valid reason to touch your emergency fund.
A fair rule of thumb before even thinking about touching your emergency fund is to ask yourself a few questions.
- Is the situation URGENT?
- Do I NEED to spend the money right now?
- Was this expense UNEXPECTED?