Wherever you are on your financial journey, the whole concept of an emergency fund is an important cog in the wheel. Back in December, I walked through a basic guide of setting up a starter emergency fund. You may be still building up to that $1,000, and maybe you are there already and ready to get your emergency fund fully funded.
For my family, getting the emergency fund set up is a critical part of our financial plan. After losing two jobs in just over a year, it had become very clear why we needed it. Initially, I thought the $1,000 along with some savings, would tide us over until I found a job. A thousand dollars goes away really fast when you are looking at mortgage, food, bills, and more. That is why one of our short term goals is to get our emergency fund fully funded. Most experts say that to fully fund your emergency savings, you should have 3-6 months of living expenses. I am going to cover how to determine a month of expenses, but let’s just pick a number really quick. Let’s say your monthly expenses are $3,000. If we take that and times it by three, we get $9,000. Times it by 6 and we have $18,000. That is a lot of money, right? That is why a starter fund of $1,000 is just that, a starter emergency fund. It isn’t meant to carry you over until you get the next job.
How to Determine Your Monthly Expenses
If you have been setting up your budget each month, this process should be fairly easy to do. If you haven’t been setting and living by a budget, it will be a little more time consuming. What you need to think about: if I lost my job tomorrow (enter any emergency here), what would the absolute essential expenses I would need to still pay this month and next? We are talking the absolute basics here; mortgage, utilities, food type basics. If an emergency like losing a job arises, and you no longer are in a position where money is coming in, all the money you have will go towards paying for these basics.
So what are the basics? Most likely the basics will be your mortgage/rent, utilities, food, gas, car insurance, possible car repairs or maintenance, medical expenses and the minimum payments that are due on any debts you may have.
Again, if you are following a budget, looking at each of these categories will be really easy to determine how much you spend each month. For example, if your food/grocery bill is $385 in March, $490 in April, and $325 in May, take the highest amount paid during those months to determine the overall amount needed to cover your food costs. So if we were looking at a four month emergency fund, our food costs would be $1960. Follow this similar exercise and you will determine how much each category will be, then add it up to find your four-month emergency fund amount to cover your living expenses.
One item to consider, is your medical insurance. With the Affordable Care Act, if you are out of work for longer than 90 days and don’t have insurance, the fines will begin to accumulate. To help cover costs of medical benefits for your family, log onto www.healthcare.com and look at the online comparison to determine how much your insurance would be for each level provided. Only you will know what needs your family will have to select which plan to base your emergency fund off of. In some cases taking the penalty can be more affordable than actually signing up for medical insurance. Depending on your circumstances, you may even qualify for an exemption to either lower the penalty or to eliminate it all together. When I lost my first job, my unemployment didn’t cover all of my expenses, so I qualified to have it eliminated altogether.
Once you have determined all of your basic expenses by category and have listed them out by your highest amount, add them all up and you will have your total basic expenses. Some people recommend rounding up to the nearest 100 or even thousand dollar. If your amount totals out to $3,622.84, round the number up to $4,000. Now just take your number and multiply it by how many months you want for your emergency fund. In this case it would be $12,000-$24,000 for a 3-6 month emergency fund.
One thing to add to your thinking process on your emergency fund is to ask yourself how difficult it would be for you to replace your existing income. You may be able to easily find a similar job with similar pay, or you may find that jobs in your area of expertise are very competitive and it will be hard to find a job quickly. Take that into consideration on just how many months of living expenses you would need to have in your emergency fund.
Where Do You Park the Money?
One of the most common questions you will see if you were to google emergency fund, is where do I keep my emergency fund? I am not sure you will find many people that agree on one place to park your money. Some people will tell you to invest it, some say to put it into a mutual fund that is set up to be short-term. This may be due to the 1% or less in interest that you get by just putting it into a savings account at your local bank or credit union.
One thing I will tell you, is that an emergency fund is set up to cover emergencies. Your emergency fund needs to be “liquid”, meaning it needs to be fairly easy to get access to. A basic savings account is a simple place to put it, as you can get to it simply by going to the ATM machine and withdrawing cash. Be sure that wherever you park your emergency fund, that it has low volatility. In other words, the value shouldn’t fluctuate much on a day-to-day basis. In general, just be sure that it will be safe and accessible.
Initially, you may want to set up a separate savings account that is not directly connected to the rest of your accounts. If you think you will be tempted to spend any extra cash that comes in on payday, consider setting up a direct deposit for your emergency fund. Just determine how much you want to deposit each check and then set it up with the payroll manager at your company.
Fully funding an emergency fund may not be the most exciting part of creating your financial independence, but having the safety net in place for when something happens will be worth more to you than however much money you have in it. You don’t have to fund it all at once, set up your goal of when you want it funded. By taking the steps to creating your emergency fund now, you will find it can keep you on the right path financially when life’s events try to knock you off. And remember, in the case of an emergency, use the funds you have saved for it, but don’t forget to refill the fund when you begin receiving your steady paycheck.
Question: What questions do you have about emergency funds? Do you have one? Where do you park yours? You can leave a comment by clicking here.