An emergency fund is money you’ve put aside specifically to help you handle unexpected financial situations that may arise. Even the most financially stable and responsible individuals need an emergency fund, because while financial planning can help you prepare for some unexpected financial events, there are also plenty that are out of your control. But how big should your emergency fund be? Let’s take a look at this question below.
If you need assistance with your finances, work with a professional financial advisor from Good Life Financial Advisors of Mt. Pleasant. We’re ready to help create a personalized plan for your specific needs.
Why You Need an Emergency Fund
An emergency fund is vital to every aspect of your financial plan. If unexpected expenses occur, ranging anywhere from unemployment to a new part for your car, an emergency fund can help cover these expenses. An emergency fund allows you to handle a financial setback while keeping your other goals on track. Thanks to an appropriately sized emergency fund, you won’t need to give up on your budget or take money from your retirement savings in order to weather the financial storm. This can keep a bad situation from becoming worse, such as forcing you to take on credit card debt.
The financial stability than an emergency fund provides can also help limit stress. When you know you’re prepared for an emergency, you can rest easy, and when a financial setback does occur, you can avoid the stress of having it derail your life and finances.
The Right Size for Your Emergency Fund
The general rule of thumb is that an emergency fund should cover three to six months of essential expenses. Essential expenses include the expenses you would absolutely need to cover, such as your rent or mortgage, utilities, groceries, etc. They do not include the expenses you could live without, if necessary, such as gym memberships or new clothes.
While the three to six months rule provides a good starting point, it’s also a wide range. Where you fall in that range will depend largely upon the level of stability in your life. If you’re a dual income household where both jobs provide steady income, you’ll likely need closer to three months of expenses. On the other hand, if you’re a single income household with a family to support and a job with less stability, such as one that relies mostly on commissions, you’ll probably need closer to six months of expenses.
If You Don’t Have an Emergency Fund
For some people, especially those who currently have no emergency fund, three to six months of expenses may feel like an impossible amount to save. If this is the case, instead of giving up entirely, start smaller and instead aim for $1,000. Three to six months is ideal, but even $1,000 can often help keep financial setbacks from snowballing into even worse situations. If you struggle to find money to save, creating a budget may help.
Uses of an Emergency Fund
Once you have an emergency fund, the key to benefitting from it is only using it for true emergencies. Putting this money towards other purchases such as vacations, eating out, the latest technology, or anything else, is stealing from your future self. You will almost certainly need at least some of this money at some point in the future, and you’ve worked hard to save it. If you have something specific in mind that you’re saving for, this should occur separately from your emergency fund.
Replenishing Your Emergency Fund
If you use money from your emergency fund, as soon as you’re able, you should replace it. If you struggle to prioritize re-funding your emergency fund, consider what you used the money for and how much it helped you. You have proof of just how beneficial your emergency fund can be.
You should also check in periodically or after major life events to ensure your emergency fund is still the appropriate size. For example, if you get married, have a child, or retire, you may need to adjust the size of your emergency fund.
Overfunding Your Emergency Fund
When it comes to emergency funds, it’s possible to have too much of a good thing. While it’s usually better to have slightly more than you may need than slightly less, overfunding your emergency fund may have negative financial consequences. Emergency funds are usually kept in a savings account, or if they are invested, they’re invested very conservatively. While this is an appropriate strategy, if you have too much set aside in an emergency fund, it means you’re missing out on other opportunities where you could have higher long-term earning potential.
Work With a Professional Financial Advisor
We hope you have a better understanding of how big your emergency should be. If you’re still unsure, consider working with a financial advisor from Good Life Financial Advisors of Mount Pleasant. We look forward to answering any questions you may have!
