“Doesn’t expecting the unexpected make the unexpected expected?…”
– Bob Dylan
Yes, Bob. Yes it does.
Any well-prepared financial plan must include this very important caveat: Expect the unexpected. You cannot properly plan for the future without recognizing the realities of life and the unpredictability that comes along with it.
We’ve all been there. Your car breaks down. You tear your calf muscle dancing with your kids. Your AC suddenly needs to be replaced in the middle of a heat wave. You lose your job due to a once-in-a-century global pandemic…
Life can come at you fast, as they say. But if you live under the assumption that these kinds of things ARE going to happen to you from time to time, and that it’s unfortunately impossible to know the exact timing of each, you can make sure that an unexpected emergency doesn’t become a financial catastrophe.
So, let’s talk about something most financial planners believe to be the foundational piece of any solid financial plan – an emergency fund.
What is an emergency fund?
When you hear us refer to an emergency fund, we’re talking specifically about a designated amount of money you have set aside specifically to be used ONLY for truly unexpected costs in your life.
How important is having an emergency fund?
The emergency fund is widely recognized as the foundational step and first priority for anyone attempting to get their financial house in order and plan for the future. And yet, according to a 2019 Bankrate Survey, about 30% of American households have no emergency savings whatsoever.
For far too many, a sudden financial emergency will mean digging further into high interest debt using credit cards, or even asking family members for help. Many that are dealing with debt often think paying off their debt should be their top financial priority. In many cases, we would agree. But NOT if you don’t have an emergency fund.
Having this financial cushion that you know you can always count on in an emergency means that those unexpected expenses, which we should all come to expect from time to time, should not interfere with the rest of your financial goals, like getting out of debt or saving for retirement.
How much should I have in my emergency fund?
At a minimum, your goal should be to maintain a balance equal to approximately three months of your household’s essential living expenses, like rent/mortgage, utilities, transportation, medicine, and food.
However, depending on your situation, up to six months worth of these expenses may be more appropriate to shoot for, at least in the long run.
Where should I keep my emergency fund?
This money must have a specific purpose. And that purpose is FOR EMERGENCIES ONLY. Keeping this money separate from the rest of your bank accounts makes the most sense for a lot of people. That said, it’s important that this money be easy to access quickly.
At blooom, we generally recommend opening an online “high-yield” savings account for an emergency fund. We often suggest opening this account at a separate institution from your checking or other savings accounts, just to make it less tempting to use for other, non-emergency purposes.
What are some ways to get started building an emergency fund?
While goals like saving for retirement and eliminating credit card debt should always be priorities, we suggest putting a pause on these goals until you have a minimum of three months of expenses in your emergency fund. So what does that mean exactly?
If you receive a match on your 401k contributions at work, DO NOT stop contributing altogether to your 401k. But if you are currently contributing more than the amount your employer matches, it may be a good idea to reduce those contributions to free up some extra money you can use to build your emergency fund. Just make sure you bump those contributions back up when you can!
If you have credit card debt you’re aggressively trying to pay down, it’s obviously important to keep making those minimum payments, but consider diverting any extra money you may be paying each month, toward your emergency fund instead. At least until you’ve managed to hit that three month savings goal. Remember that one of the most effective ways to eliminate debt from your life is to make sure you aren’t digging further into debt when unexpected costs come up. Get that emergency fund!
When it comes to just about any savings goal, we cannot possibly overstate the benefits of automation. Setup automatic transfers weekly, monthly, or even daily into your emergency fund to keep the process effortless on your end.
If you need to, start with a very small amount of money for each transfer just to see what impact this has (or doesn’t really have) on your cash flow, and then you can begin to increase that amount over time until you’ve hit your goal. It’s much easier than you think and setting milestones you can celebrate, like saving your first $1,000, might even make the process…dare we say, a little fun?!