A few years ago, we watched with horror as Hurricane Sandy roared up the East Coast of the United States. We saw the devastation that a storm can cause, both in a physical sense and in an emotional one. Some of America’s largest cities were severely damaged. The power of nature is truly an awesome sight to behold.
As with any big storm, scores of people decided either to ignore the evacuation warnings or had no choice but to ride the storm out in their homes. Now, there are tens of thousands of people trapped. There are millions of people without electricity. Unless they prepared properly, many of those people are without food or water. Federal, state, and local governments are scrambling to provide these people with the aid that they need in order to survive the next few days.
While there is obviously no way that humans can stop a huge storm like this from affecting their homes, individual people and families do have the opportunity to prepare for such an event. If somebody plans to ride out a storm, they need to stock up on certain items in order to ensure their survival. In the event that aid can not reach them for several days, or even weeks, those that chose to ride the storm out had better hope that they prepared properly for that variable.
The same is true for people who are experiencing a financial storm in their own lives. While it is not always possible to avoid a personal financial crisis, it is important for every one of us to prepare for the possibility of one. How do we do that? The key is simple. We all need to have an emergency fund.
What is an Emergency Fund?
One of the major reasons that many people never seem to have any money is because they fail to prepare for simple financial emergencies. Rather than saving money for unexpected events, they spend all of their money each month. When the furnace breaks or they need an immediate repair to their car, it wipes out their savings. That is why it is important for everybody to have an emergency fund.
An emergency fund is essentially a savings account from which you only pay for things in the event of a financial emergency. Your emergency fund money can be kept in a separate account or it can be mixed with your regular savings. If you choose to do this, you must be sure to not spend your emergency fund money on other expenses. You should have a “floor” in mind for your savings account balance and not let it dip below that number, replacing any money spent as soon as possible. Either way, this money should be placed in an account that is liquid. In other words, you should not invest your emergency fund money in stocks or mutual funds – both because they are illiquid and because you do not want to put your emergency fund at risk.
How Much Money Do I Need in My Emergency Fund?
The trick to having an emergency fund is to have enough money for emergencies but not so much so that you are missing out on making additional money through investments. Ideally, your emergency fund would include 6-12 months of living expenses. Therefore, if you experience the ultimate financial storm of losing your job/income, your living expenses are covered for 6-12 months. That should give you time, hopefully, to find another job and get back on your feet. This also means that you will need to complete a written budget so that you know exactly how much your monthly living expenses so that you’ll know how much to save. In addition, any money from your emergency fund that is spent should be replaced as soon as possible.
Until you have fully funded your emergency fund, you should allocate money for it in your monthly budget. Building an emergency fund takes time, and you may need to do it in increments. We recommend that you start with a small emergency fund of $1,000-3,000. Once you have your starter emergency fund, we recommend that you pay off all of your consumer debt before attempting to fund your 6-12 months of living expenses. Then, once you are debt free (except for the mortgage), you should begin to stuff money into that emergency fund until it is fully funded. At that point, you will know the peace that comes with being able to weather almost any financial storm.