No matter how well you budget, this spending plan won’t always be right. You can hit a rough patch that throws unexpected expenses your way.
Your car needs a new transmission the same week you get sick and need to pay for antibiotics. The very next day, your furnace stops turning on, and you wind up at the vet when your dog gets bit at the off-leash park.
While your budget might have some floating cash to deal with one of these surprise expenses, it may not be enough money to handle several urgent expenses at once.
Sound stressful?
Dealing with a surge of expenses you don’t normally handle is easier when you have an emergency fund. This fund grows from your monthly floating cash until that excess grows into a sizeable nest egg. Given enough time, it can cover all the unexpected expenses above, plus a larger emergency like a job loss.
The Lifecycle of an Emergency Fund
In a perfect world, your emergency fund will sprout into existence fully formed. Here in reality, it’s something that you grow incrementally over time.
Here’s what it might look like as you take on this savings goal.
Nothing | The Beginning
You might boast $0 in your emergency fund at the start of your savings journey. That’s normal — more than one in five Americans have no emergency savings.
So, what do they do when they run into financial trouble? Most turn to personal loans or lines of credit. These financial products may provide a lifesaving safety net, subbing in for your emergency fund when it’s nearing empty.
Setting up a line of credit or borrowing a personal loan is simple and convenient when you go online. You may try to apply today and get started using nothing but your phone, a secure network, and basic financial information. While personal loans may not be a long-term solution, having these financial products may provide momentary relief in emergencies.
$1,000 | A Foundation
Every year, the Federal Reserve publishes its Economic Well-Being of U.S. Households. This report tracks how easily Americans can afford a $400 emergency expense.
At $1,000, your emergency fund is more than capable of covering this $400 benchmark. You can even cover a few $400 expenses before you turn to a personal loan or line of credit.
In the grand scheme of your life, $1,000 may not seem like much. But it’s a huge goal for first-time savers. It provides a foundation, giving you a sense of financial security. More importantly, it shows that saving money works.
1 Month of Living Expenses | Decent Coverage for Low-Income Households
Before this guide gets to the bigger savings goals, let’s pause here for a moment. Saving is one of the hardest things you do in today’s economic landscape. For many low-income families, saving one month of living expenses would take two years to complete. Saving anything beyond this is a huge undertaking when dealing with inflation.
The good news is that you may not need much more to feel secure. A study conducted by the University of Colorado and Universidad Andres Bello shows that 95% of low-income families need about $2,467 set aside for emergencies. That’s roughly the equivalent of one month’s pay for low-income workers.
3 Months of Living Expenses | The Ideal
While an emergency can come in all shapes and sizes, research shows they average out to about $1,700. Most people also tend to run into an unexpected expense every 90 days or so. The unexpected is a consistent and expensive drain on your emergency fund.
As a result, most financial advisors recommend you save at least three months of living expenses. This is the bottom figure of their ideal range, the top of which we’ll explore more later.
Since this goal reflects your typical spending habits, there’s no one-size-fits-all number. Instead, you have to track your spending to find out how much you need to cover all your typical expenses over a three-month period.
6 Months of Living Expenses | The Ideal
Six months of living expenses rounds out most financial advisors’ ideal range. At twice the previous goal, it’s twice as capable of handling life’s toughest emergencies. You’ll be able to deal with several consecutive unexpected expenses. Plus, it gives you six months to recover from a life-altering illness or lay off.
1 Year of Living Expenses | For Conservative Outlooks
Three to six months of living expenses is the most common range repeated by many financial advisors all over the world. However, some advisors don’t think this range provides enough protection in today’s rocky economy.
For these risk-averse advisors, you need to save a full year of living expenses in an emergency fund. This gives you a full year to bounce back from job interruptions or health emergencies. It’s also more than enough to handle an appliance repair, vet expense, and prescription — even if they all land in the same week.
Do you need to be this cautious? When money is tight, you have to ask yourself if this goal is worth your time. Consider your risk tolerance as well as your lifestyle when coming to a decision. Typically, people who work in volatile industries or have a lot of dependants may feel safer with this fund.
What to Do After You Reach Your Goal?
Once you hit your goal, celebrate. No really! Saving this much money is no easy feat, so you should acknowledge how much time and effort went into this task.
After the party dies down, it’s time to focus on other areas of your finances. Once you have the safety of an emergency fund at your side, don’t just keep shoving money at this account.
A bloated emergency fund doesn’t help you as much as you might think. It can prevent you from taking other essential financial steps, like investing.
Investing is a privilege not many people get when they lack savings or are in debt, so take advantage of your full emergency fund and invest in your future. Identify your goals and risk tolerance, then talk to an investment professional. Together, you can start to establish a diversified portfolio that will help you achieve long-term goals, like retirement.
Replenish your fund if you use it, but otherwise, start saving towards a long-term investment instead.
Bottom Line:
An emergency fund might emerge in different stages. Assess these stages, choosing where you want to stop to feel secure. Creating a resilient emergency fund can help you face life’s uncertainties with confidence.
