No financial plan is complete without an emergency fund. It acts as protection against life’s unexpected expenses; these are things like job loss, illness, major home repairs, or any other unplanned (and often unpleasant) events that surprise us. While many of these events are uncomfortable on their own, when you don’t have the cash on hand to cover these costs it’s almost guaranteed to make the situation worse.
Here are some questions you should ask yourself when setting up your emergency savings.
How much should I save?
There is no set dollar amount that every person should have tucked away in their emergency fund; instead, it should be based on your personal circumstances. Most financial advisors agree that everyone should have enough money in their emergency account to cover three to six months of “fixed and variable” expenses. Some financial advisors even suggest more, but few recommend less than three months’ worth of savings. Typically the deciding factor on how many months you should be able to cover depends on if you have additional income sources. Less additional sources mean more savings.
What are my “fixed and variable” expenses?
“Fixed and variable” expenses are the items that you must pay for on a monthly basis. These are not your discretionary expenses like going out to eat with friends or your gym membership. Here’s a quick list of common “fixed and variable” expenses:
Housing – your rent or mortgage, insurance, property tax and utilities
Personal Living Expenses – this should cover anything from groceries to gas
Health Care – include the monthly cost for medical and dental insurance
Debt – protect your credit score even during times of trouble and continue making your regular payments
Income and FICA Taxes – Uncle Sam doesn’t care about your emergency. Be sure you can pay your tax bill when the time rolls around.
It’s best to be as detailed and accurate as possible when calculating exactly how much money you need to cover each month in your emergency account. You don’t want to find yourself short in an emergency, but you also don’t want to have cash sitting (and not compounding) unnecessarily in this account either.
Where should I keep it?
Your emergency fund should be completely liquid and kept somewhere that you can easily access it. Most people choose to keep it in a money market or bank account. While you can’t make huge returns on cash in the bank, the peace of mind that your emergency account should give you is well worth the price.
If you’re looking for some help, you can create a free Wela account and fill out a Game Plan. Our team can help you determine how much you should have set aside for emergencies, and help with prioritizing your savings and debt strategies.