Emergency Funds

Now that you have at least a basic checking account setup it is time to start thinking about a savings account. The first savings you should build up is your emergency fund. This fund is your fiscal backup for when things go wrong. There are more schools of thought on emergencies funds than you can shake a stick at, for now lets look at what they are for.

Many people consider an emergency fund as replacement income when they lose their job. In fact the emergency fund is for any unexpected expense that you can’t fund directly out of your checking or cash account. This can include anything from a termite invasion to a broken down car. I want to reiterate here that this is not a “I need a shed for the back yard account”, it is a “holy hell the engine just fell out of my pinto” account.  Basically if you aren’t freaking out about it, you probably shouldn’t be dipping into your emergency fund.

The biggest key to your emergency fund is to only use it for bonafide emergencies. There are certain things people tend to dip into their e-funds for that should be planned expenses that come out of a separate bucket of money. These types of expenses include car tires, car brakes, home maintenance, and insurance. These are all things you should expect to have to pay for and therefore should already have been putting money aside for them. If you get an account at ING Direct you can easily setup sub accounts you can designate for these eventualities that aren’t emergencies.

But Kyle How Much do I Need?

I hate the answers to this question, so I feel almost dirty trying to give you an idea here. The reason I hate it so much is that I don’t know you, I don’t know your situation, and I don’t know your comfort level. The true answer to the question, how much money do I need for an emergency fund? is “It Depends.“ There are a couple of schools of thought here, Dave Ramsey for instance recommends that you cap off your initial fund at $1,000 until you have paid off your consumer debt. This could work for some people, however, it would make me nervous as all hell to have that little money in the account. Of course $1,000 wouldn’t even pay my mortgage payment for one month.

The best way to get started is to calculate your minimum monthly expenses required for you to survive. Basically this should amount to the necessities such as lodging, food, and utilities. You then take that magic number amount and multiply that times the number of months you think you need to be comfortable. For a single income family you might want to have at least 6 months, if not more saved up. If you live in a dual income family like me than you probably don’t need but 3 months because it is very unlikely that both you and your spouse would lose their jobs. One school of thought for determining the number of months you should have saved up is to use the unemployment rate to determine how much savings you need. The current unemployment rate in the U.S. is 9.4% based on this rule of thumb you should have at  least 9.4 months of savings in your emergency fund.

Photo: (Pkeleher)

This is the second of a multi part Back to the Basics series. I plan to cover remedial personal finance topics which aren’t as sexy, or typically covered, in the personal finance blogosphere. My hope is for people to get a better understanding of basic personal finance without boring you to death, hopefully you will be able to share these posts with family and friends to get them into personal finance and have a good foundation of knowledge.

Tagged as: Back to Basics