What is an emergency fund?
An emergency fund is cash set aside for unexpected expenses. These can include financial emergencies such as home repairs, medical bills, or even losing a job. The emergency fund is not a part of general spending and should only be used under certain circumstances, serving as a key factor in staying out of debt.
Why is it important?
Having an emergency fund is vital because any financial setback, small or large, can become long-lasting debt if it is not paid off quickly. With some cash ready for unanticipated situations, money needed for sudden financial emergencies can be taken care of easily. Otherwise, it would just be an additional thing to worry about.
How much money should be in it?
Although the emergency fund amount depends on the individual’s lifestyle, income, and many other factors, an amount that covers at least three to six months’ worth of expenses is a widely recognized target. Even if a person is already in debt or thinks that they will never need any backup cash, it never hurts to have an emergency fund, and it is one of the first steps to maintaining a balanced financial life.
How does one build it?
The optimal strategy to save for an emergency fund would depend on the individual; however, there are numerous common elements that should be taken into consideration. The first step is to set a goal, which will offer motivation and help to keep track of savings. The second step is to save consistently by saving a specific amount each day or each week. This may require less effort for those with a consistent income, and it will allow the fund to build constantly to reach the goal. Then, it is best to monitor the progress regularly to ensure that a day was not accidentally skipped and that progress is being made. Finally, after following a consistent plan to create the emergency fund, the goal will be achieved! Then, another financial goal can be made based on the individual’s interests.
In what situations should it be used?
It’s in the name. An emergency fund should be used for emergencies. Emergencies include job loss, income reduction, medical bills, home repairs, and other circumstances that may cause significant financial burdens. Emergencies do NOT include things that are unnecessary to survival, such as purchasing a new cell phone. Situations such as losing a job or paying medical bills are far more important than the purchase of a luxury good, which is why the emergency fund was created in the first place.
Where should it be kept?
There are multiple options to store the emergency fund, and any can be chosen based on personal preference since different options have their own benefits and drawbacks. One option is to keep it in a bank or credit union account. This is considered one of the safest options, and it may be easier to have an account dedicated to storing emergency funds. Another option is to keep it on a prepaid card. This card would not be connected to any institutions, and only the amount on the card can be spent. An alternative to these choices is cash. This can be kept at home or with a trusted individual, but it is easier for it to get lost or stolen.
Overall, the emergency fund is a critical aspect of reaching financial success. It is very convenient to have in unpredicted situations and is a great tool to stay out of debt. In fact, it is not difficult to build, and it can only provide help for the future.
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