People who've had large and unforeseen expenses arise can probably either tell you how happy they were that they had emergency funds, or how difficult it was to find the money to cover expenses. As with most finance-related issues, pre-planning is a key factor in successfully weathering the storms we are all sure to face in life, though recent statistics show some rather alarming results. It's estimated that 28% of Americans have no emergency savings, and a recent poll shows that a whopping 49% of Canadians between ages 18 and 44 haven't set any money aside to cover emergencies.
The What and Why
An emergency fund is essentially money that's been set aside to cover any of life's unexpected events. This money will allow you to live for a few months should you happen to lose your job or if something unexpected comes up that will cost a fair chunk of money to cover. Think of it as an insurance policy. Rather than paying premiums to an insurance company, you're setting aside money for yourself that can be used at a later date. This money can then be accessed quickly and easily if some unfortunate event happens to occur.
Determining an Amount
Many banks and financial experts suggest that you should save at least three months worth of salary in your emergency fund. That way if you do lose a job, you'll have enough money to get by for a few months until you can find replacement work. However, depending upon your preferences and income level, the amount can vary. You should first calculate what your living expenses are. Tally up how much you spend each month on mortgage or rent, utility bills, groceries and vehicle expenses. You should have at least enough to cover your living expenses for three months, and probably even more.
If you're in a double-income household and are unlikely to find both income earners unemployed at one time, you can rely on the assistance of financially-stable family members. If you have insurance policies that will cover you for unexpected emergencies, you may be able to get by with the bare minimum. However, each and every person should make a point of setting aside at least something for unforeseen expenses.
Sticking to Your Goals
With most goals, setting a plan and sticking to it is the surest way to be successful. Look at opening an account that can't be accessed with your debit card, like an e-savings account. Automate transfers to this designated account from your primary bank account to match up with your pay days so that you won't even see the money in your account. You can't miss what wasn't there, and you won't feel the urge to spend it. Once you have a large enough sum saved in this liquid account, you can transfer some to short-term bonds or high-interest savings accounts that you can still access fairly easily in times of need.
When to Use It
There may be times when it will be tempting to use this money toward a vacation, paying off significant debts, putting a down payment on a new home or any other significant expense that arises. You should always create a list of acceptable expenses that this money has been designated for. Ensure that they are true emergencies - things like covering your living costs during periods of unemployment, medical emergencies, paying for repairs to your home that occur as a result of a natural disaster or fire, emergency veterinarian bills, unforeseen vehicle repairs, or even tax bills that were unexpected. The whole point of this fund is to prevent you from having to add to your debt in times of need or scrambling to wrangle up the money at the last minute. You definitely want to ensure that this money is safely stowed in your account for those occasions when you need it.
Saving Vs. Paying Down Debt
There is much debate on which approach is better when it comes to choosing whether to focus on paying down debts first or building up your emergency savings. There are pros and cons to each approach. Paying down high-interest debt should always be your first priority when it comes to prioritizing debt repayments, but that doesn't mean that you shouldn't be setting some money aside every month as well. Striking a balance is the best approach. This helps to build good money habits and will prevent you from having to borrow money if an emergency does arise. If you are in a situation where you're paying off debts, look at how much you can reasonably afford to contribute to your emergency fund instead. Even if it's only $25, this is the beginning of a good financial habit, and this money will continue to grow as your debt load diminishes.
The Bottom Line
Although it may seem challenging or perhaps even pointless to live below your means, you'll probably be happy that you did when that rainy day arrives and the overall impact to your financial well-being is minimal. Focus on changing your mindset. The only person you can really depend upon to get you out of trouble is yourself. Don't rely on family, friends, government safety nets, insurance policies or just plain luck. Bad things can happy to anyone, and working toward financial health should be just as much a priority as looking after your physical health.