When making out a monthly budget, some people forget to allocate a portion of their income to their emergency fund. They might think that this is fine for the short-term, but it definitely is not sustainable for the long-term. Having a certain amount of cash set aside is essential in case any unforeseen circumstances were to occur.
Why is an emergency fund needed?
Living paycheck to paycheck is very stressful, and not the ideal arrangement for many Americans. If you were to lose your job unexpectedly or have to pay a massive bill, there needs to be some money set aside for those things. Financial setbacks are going to happen in life, there is no escaping that. Having some cash stored away for that rainy day can be the difference between you getting by until you are on your feet again, and you losing everything.
Keep in mind that your emergency fund needs to be liquid. This means that you need to be able to get at the money right away if you need to. Investing the fund in a locked portfolio will be no help to you, as you cannot access it immediately. The best bet would be to keep your fund in a savings account, with as high of an interest rate that you can get.
What should you use emergency funds for?
This is another thing that people get confused about. What exactly qualifies as an emergency? Typically, this money would be used to sustain yourself for a couple of months if you lost your job. It can also be used for any type of unexpected bill, such as for healthcare, home or auto repair, or the sudden need to leave your current living situation.
How much should be in the fund?
Your emergency fund should be fairly substantial. After all, you have no idea what it might be needed for, so it is better to be overprepared rather than underprepared. A common rule of thumb is to have enough in your fund to keep you afloat for 3-6 months. That includes all the necessary monthly expenses such as rent, utilities, and food. During this time, all unnecessary spending should be completely stopped.
A reasonable emergency fund for a 6-month period of time should be about $10,000 – $12,000. If we take the average of these two, that means that 1 month of essential expenses is about $1,830. Of course, it can be difficult to save up this kind of money all at once. This is why it is important to keep the emergency fund in mind while budgeting every month. If you plan to save $300 per month for your emergency fund, you will have a sufficient balance in a little over 3 years. If you have extra money at any time, you can contribute that towards your emergency fund as well, which will bring the timeframe down. Once you feel secure in the amount that is stored away, you can start to relax and use your money for other things again.