What is an Emergency Fund?
Maintaining an emergency fund is a crucial part of financial planning. There are times in your life when you will have unexpected expenses and need cash on hand. Whether you are facing unemployment, medical expenses, car repairs, or some other dilemma, this money can keep you afloat. You can think of your emergency fund as your safety net during uncertain times.
Having liquid assets readily available is one way to improve your financial security. A rainy day fund reduces the need for high interest loans or credit cards to pay your bills. It also prevents you from drawing money from your retirement funds. These liquid assets can be used to pay off your emergency expenses without sending you deeper into debt.
How Much Should I Contribute to My Emergency Fund?
I was more fortunate that most teenagers. My father is a very frugal man and taught me the importance of saving money from a very early age. When I received my first paycheck, he told me I had to deposit 25% into my savings account every month. This seemed like an astronomical number and completely unnecessary since I didn’t have many expenses as a 16 year old. However, my dad explained the importance of having a ‘rainy day’ fund in case of emergencies. Sure enough, I needed immediate cash only a few months later when I got into a fender bender and had to pay for car repairs. After that, I began contributing 50% of each paycheck towards my emergency fund.
Most financial planners will tell you to keep enough money to cover your expenses for three to six months. However, the right amount largely depends on your personal financial situation. To determine what your personal goals should be, you must first know what your monthly expenses are. Once you have a clear idea of your monthly expenses and spending habits, you can make a plan.
Executing Your Plan
When you calculate you total household expenses, the final tally that covers half a year of expenses may be overwhelming. It’s important to stay focused and remind yourself that you have to start from somewhere. The key to reaching your goal is making consistent contributions. If you approach it as if you were paying another bill, it will quickly become a habit. For those barely making ends meet, remember every penny counts. Even if you are only able to set aside $5 a day, it will accumulate to a nice sum of $1,825 within a year.
Keep in mind there are other ways to free up cash to add to your emergency fund. Collecting change at the end of each day is a great way to establish good savings habits and teach your children an important financial lesson. You can also request rate reductions from your credit card companies to lower your monthly interest rates. Furthermore, you can save a lot of money by downgrading services and memberships or comparing prices. There are dozens of other ways to trim the fat and live within a strict budget.
The sole purpose of building an emergency fund is to ensure that you can maintain a normal lifestyle when life throws you a curve ball. This money should only be used for true emergencies, so look into a separate, high-interest savings account for safekeeping. This will deter you when you are tempted to dip into your funds. On the other hand, it will still give you quick access to liquid assets when you need it. Having an emergency fund gives you room to breathe during difficult financial times.
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