Wherever you are in your journey to financial wellness you should know the importance of an emergency fund. As stated in my previous post, the COVID-19 pandemic has highlighted the importance of having an adequate amount of money set aside for emergencies. While you know that you should have one, the tricky part is determining what amount will give you adequate security and cover any unexpected events. This post will provide guidance on how to establish an emergency fund and determine how much money you really need.
1. Create A Household Budget
The best way to know how much you need in your emergency fund is to create a household budget. This should track your income and your expenses, which will help determine how much to set aside and how big the fund should be. If you are detailed in how you record your budget you may have separate categories like fixed expenses and variable expenses, or expenses that are necessities and those that are wants. This distinction can help you identify areas where you can cut back, with the added benefit of increasing the amount available to be put towards your emergency fund. A budget can also give guidance on how long it may take to get to your desired emergency fund amount. Remember, you determine how long that takes by the amount you decide to set aside each month.
2. Set Up Automatic Deductions
Ever heard the phrase ‘pay yourself first’? Well one way to fund your emergency fund is to literally pay yourself first. Schedule automatic transfers to your savings account each time you get paid. This makes your emergency fund a priority and limits your ability to yield to the temptation of spending that money on something frivolous. Once you have achieved your desired goal you can cancel the automatic payment and resist the urge to pull money out of that account. In fact, treat that account as if it does not exist unless an emergency occurs.
3. One Size Does Not Fit All
When it comes to emergency funds, the amount you put away will depend on you. Most resources recommend an amount equivalent to 3 – 6 months’ worth of expenses. Personally, I strive to achieve 6 months’ worth of take home income. A friend of mine prefers to have 3 months’ worth of necessities (expenses excluding discretionary spending). If you have already completed step #1 then you already know how much each of these amounts are.
Remember, the point is that your emergency fund should suit your needs. It should be an amount that you can achieve and maintain. Choose an amount that provides security for you and suits your lifestyle. The more concerned you are about your finances, the more you should set aside.
An emergency fund is non-negotiable when you have decided to take control of your finances. Whatever method you choose to use to achieve your desired amount, the most important thing is that you start saving now. Having this resource available can be the difference between being able to afford to keep your home in hard times or being homeless.