Do You Need an Emergency Savings?
Having an emergency fund is one of the best financial decisions you will ever make.
The short answer - yes! YOU need an emergency savings!
What is an emergency savings?
Emergency savings is a savings account that you dedicate specifically to paying for large, unexpected expenses.
What’s an emergency:
Unexpected medical bill
Major car repair
Unemployment
Unexpected home repair
What’s not an emergency:
Concert tickets
A sale at your favorite shoe store
A vacation
A new car
A new chair for your office
Emergency savings are meant to be left for true emergencies in your life. They’re meant to provide a safety net so when something goes wrong you have some money set aside to help you through.
Why do I need an emergency fund?
First, because emergencies, by definition, are unplanned. You never know when an emergency might happen and you get hit with a huge bill that you weren’t expecting.
Second, because here’s what happens if you don’t have an emergency fund when an emergency does occur:
You have to put it on your credit card, or you have to take out a personal loan from the bank, both of which are going to charge you incredibly high interest rates for borrowing the money
For example, say you had a trip to the emergency room and it cost you $5,000. If you have an emergency fund, you pay the bill, go home, and recover your health.
But let’s say you put that $5,000 on a credit card at 18% interest, and you pay $100/month. It will take you over seven years to pay the balance, and you’ll end up paying over $4,000 in interest. That’s almost double the amount of the original bill!!
Having an emergency fund can dramatically reduce stress, because you know that you have a lump-sum of cash set aside when an emergency does happen. You don’t have to worry about how you are going to pay for emergency surgery, a burst pipe or an engine problem. You’ve got this.
How much money should I save in an emergency fund?
At a minimum, you should keep 3 months of living expenses in an emergency fund. This will make sure you have a little buffer in your budget if something comes up.
Even better, try for 6 months of living expenses. If you lose your job, you’ve got 6 months to find a new one before you have to really start penny pinching. This should give you the time you need to find a position that works well for you, instead of having to take the first one that comes up because you need the money.
If you work a 9-5 job, 6 months of living expenses in emergency savings is probably the most that you need. After that, it’s time to start adding more money into your investments. But, if you’re an entrepreneur or someone that has irregular income, it’s better to save up a year of living expenses. I know this sounds like a lot of saving, but if you do not have a steady paycheck coming in every two weeks, you want to have a very generous buffer to make sure you’re taken care of.
Where do I put my emergency fund?
The best place to put your emergency savings is in a high yield savings account. A high yield savings account is just like a regular savings account, but you receive more interest for your money. That’s it.
If you have $10,000 in an emergency savings account, a regular savings account will give you about 0.01% ($1.00 per year). A high yield savings account might pay you 4.25% ($425 per year). That’s a HUGE difference!
*Note: interest rates on high yield savings accounts do vary depending on the bank and market conditions, but they’re usually between 2-4%.
How to make your own emergency savings account:
Open up a high-yield savings account
Do a quick audit of your monthly expenses and find out your “needs” costs for one month. Needs are things that you have to pay or you’ll suffer physical or financial consequences. Think: rent, car payment, health insurance, student loan payment, groceries.
Multiply your “needs” number by x3 for three months of savings, x6 for six months or x12 for one year of savings. This is the number you are aiming to have in your emergency savings.
Decide how much you are able to contribute per month to grow your savings. Then set up an automatic transfer from your checking account to your emergency savings account every month.
Final thoughts
That’s it! Having an emergency savings is one of the best financial decisions you can make. You’ll be amazed at how different you feel knowing you have a nice, soft pillow of money to fall back on, if or when an emergency happens.
Your life may not be perfect, but it is imperfectly yours. The only way to live it is your way.
