One thing that 2020 has shown is that life and your financial situation can change very quickly. Unfortunately, emergencies can come at any anytime and in many different forms. There may be situations where you have reduced pay or unemployed. In any case, emergencies are always unexpected and the best thing you can do is be prepared.
By planning ahead for financial emergencies you’ll be better prepared without financial hardship.
One way to help weather the storm of life is to have an emergency fund. An emergency fund is money that is in a liquid account. A liquid account is a financial account that has cash readily available.
How much should I have saved in an emergency fund?
The general consensus from financial advisors is 3 to 6 months. This means that you have enough liquid assets to cover your immediate financial obligations. If you are single with minimal financial obligations, 3 months may be enough. If you have a family, mortgage, car payments, etc, 6 months would be a safer bet. These are general guidelines and the amount saved in your emergency fund depends on your current lifestyle and financial obligations.
Note: Emergencies are not only job changes, but could also include unexpected bills such as repairs, medical and emergency travel.
Where should I setup my emergency fund?
Since this is an emergency fund, you do not want an account that can be an investment that is risky or can lose money. The most common places that meet this criteria is a high yield saving account or a money market account. These are great places to store money that is easily accessible.
However, there are other places to create an emergency fund such as money market funds, but these are not FDIC-insured. However these might be SIPC-insured and usually offer higher interest rates over savings accounts. A CD (Certificate of Deposit) offer great rates, but note that they usually are frozen for a period of time. You can usually withdraw money from a CD but there usually penalties.
How can I start saving for an emergency fund?
First, treat your emergency fund as a bill. Each month find out how much you can put into a liquid asset. Little by little start saving, and overtime it will continue to grow.
Another way, is to look at your expenses and see what you can trim from your spending and allocate that money towards saving in your emergency fund.
Everyone needs to have an emergency fund no matter what your current financial status. Life can throw you unexpected expenses or change in income from a job loss, natural disasters, life expenses or even a pandemic such as Covid-19.
The best way to plan for a financial emergency is to simply have a plan.