The Importance of an Emergency Fund

Kim Tran

Personal Finance,

When it comes to money, what keeps you up at night?

A 2018 Top 10 Fears report revealed 57 percent of Americans are very afraid of not having enough money for the future. Another 53 percent said they were nervous of getting stuck with high medical bills. It makes perfect sense; 66.5 percent of all bankruptcies are tied to medical issues.

39 percent of Americans have enough savings to cover a $1,000 emergency.

This is why prioritizing an emergency fund is crucial to your financial well-being in case you need to cover a $10,000 out-of-pocket medical emergency.

How an emergency fund can help you

You never know when you will end up in an unexpected situation, requiring money to rescue you in your time of need, whether it’s a $500 car repair or $2,000 plumbing problem. There are multiple scenarios that you could come across that would warrant the need for an emergency fund as a solution, but the most common instances are explained below. 

Cover unexpected medical costs 

Health insurance plays a significant role in the expenses associated with doctor and hospital visits. Even though your policy may cover medical and routine checkups, it may not fully cover ambulance rides, hospital visits and certain procedures. 

Then there’s the deductible. If you have health insurance, you may have one. This is the maximum amount that must be paid before the insurer agrees to cover all medical costs. This amount will vary, and depending on your budget and medical needs, you may opt for a higher deductible in exchange for a lower monthly payment. An unexpected accident could result in a hefty bill that would need to come out-of-pocket. 

Provide financial cushion if you lose your job

It’s not ideal, but it happens. From 2018 to 2019, there was a 43 percent jump in unemployment resulting from job cuts. 

No one’s job is 100 percent fully secure, so to provide some stability and peace of mind, having six months to a year’s worth of living expenses saved up is ideal. The money accumulated in your emergency savings should be enough to cover all members of your household, including dependents. 

Take the first step and plan out how much you need each month to live, and then create a budget to start saving. If saving for six months’ worth of living costs is overwhelming, start small and set a three-month goal. Increase your savings each month, and put in extra money such as bonuses, income tax refunds, and gifts into this fund. 

Pay for unexpected home and car repairs 

Over time, as a home and car owner, certain expenses are unavoidable. A report revealed that 1.5 percent of the average person’s annual income, or about $817, goes to car repairs alone every year. Whether you experience an accident on your property or damage to your vehicle, both will require funds to remedy the problem. Additionally, for these types of problems, time is of the essence. 

While many people turn to their home and auto insurance to bridge the gaps in these types of emergency expenses, some policies don’t cover everything. Just like medical insurance, you’ll need to be prepared to pay out-of-pocket. This can include missing coverages for unplanned events, along with a high deductible payment that is required to restore damages. 

How much money is needed for an emergency fund?

While coming up with a budget for your emergency savings, you should think about how much money you need to live comfortably every month. As previously mentioned, experts advise having at least six months to a year’s worth of living expenses in your fund. Map out what this looks like by listing out your expenses versus your income.

Monthly expenses may include: 

  • Rent or mortgage 
  • Utilities (gas, electric, cell phone bill, Wi-Fi)
  • Car payments
  • Student loans
  • Groceries

The total needed for your emergency fund can be calculated by subtracting all necessary expenses from your monthly income, after taxes. Calculate your take-home pay (which is after taxes are taken out) and subtract your monthly bills from it. Whatever is left over is the amount you have to play with to start funding your emergency fund. 

If money is tight, start small — maybe 10 percent of your monthly income can fund your emergency fund. Whenever you have extra money, such as pay raises, bonuses, or income tax refunds, consider putting it into your emergency fund. 

How to start an emergency fund 

Start with a goal and a tangible number in mind. This ensures you have a goal to work towards, rather than generally telling yourself you need to save. Start with the number of months you want to tackle, whether it’s three months, six or a year. Then estimate how long that will take you.

Regardless of income, you can always come up with a personalized plan to start saving for your emergency fund and achieve your goal at your own pace. Here are two strategies that can help you save for your emergency fund. 

Decrease your spending 

The first step to take toward saving for an emergency fund is decreasing your current spending habits. This will free up more money in your budget, allowing you to add on to the amount that is left over after you have paid your bills for the month. 

Additional funds can come from choosing to cut back on dining out, bar tabs, entertainment, vacations, shopping, and canceling unnecessary subscription services. Assess your monthly bills, subscriptions, and spending and figure out what you can reduce or eliminate. 

If you want to make more drastic measures to boost your savings each month, consider the following action items:

  • Move to a cheaper place: This might be easier for renters, but if you can, consider a less expensive place to live. Your rent is likely the most costly monthly bill, so if you can reduce this by a few hundred dollars each month, you can throw that extra money into your emergency fund.
  • Sell your car: Consider taking public transportation, especially if you live near a big city with plenty of buses and subways. If you live in a two-car household, try selling one and share it with your partner. Plus, it’ll save you on gas.
  • Get rid of your storage unit: One in 11 Americans pay an average of $91 per month for storage, which is now a $38 billion industry. Sell your junk and rid yourself of the burden while making some extra cash.
  • Increase your income: Earning a side hustle is not only popular (more than 44 million Americans have one), but could be necessary, according to a new survey. A side hustle study showed that 1 in 3 side hustlers actually needs the income to cover living expenses.

When to use your emergency fund 

An emergency fund should not be confused with regular savings. Taking this into consideration, here are two questions that you should ask yourself before putting this money to use. Your emergency fund will serve the purpose of taking care of any expenses you have that are unexpected. This can include an unplanned trip to the hospital, job loss, sudden repairs needed around the home, or fixing your car.

Emergency money is meant for sudden but necessary expenses. So if you’ve been eyeing those $850 ski boots for the upcoming snow season, your emergency fund should not cover that.

The importance of an emergency fund is something that should be recognized more often among Americans. It is so easy to get caught up in the present that most do not think to plan for the future. Planning for the future isn’t easy, much less unexpected mishaps that may derail your budget, all together.

Nevertheless, having money tucked away for a time of need gives you peace of mind and saves your budget. Being prepared with an emergency fund is one of the smartest things you can do for yourself and your loved ones.

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