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What is an Emergency Fund?
The Financial Consumer Agency has a definition that I see as sufficiently robust. An emergency fund is a money you set aside to pay for unexpected expenses. You’ll most likely have to deal with an emergency resulting from an unexpected situation or a drop in income at some point in your lifetime.
The list of events that can constitute emergencies may be few but can become a life-changing and include:
- Job loss
- Car accidents (without adequate insurance)
- Health issues beyond your insurance coverage
- Home repair from fixtures replacement to natural disasters
- Pandemic as we now have
Any combination of the above is a good enough reason to have a buffer if things go south against your plan.
It is an easy disclosure to make that your budget or financial plan is not for an emergency, which is the purpose of this post.
What are NOT Emergency costs?
How many times have you walked out of your house having just watched your perfectly working TV and returned from the store (or online) with a brand-new TV?
The same goes for your sofa/couch, iPhone, Xbox/PlayStation; now you get it. We can splurge on these luxuries by saving for them, but they are NOT emergencies. A different post addresses items that are not worth your money.
Why Save Up an Emergency Fund?
If you are reading this article, the chance you need an emergency fund is stacked very high. My audience consists of individuals in a life phase of making meaning of their finances and creating wealth.
As Delboy said, you never know when you’d need bone marrow. The same proves true of an emergency fund. You never know when you’d need money to deal with an emergency that has made some homeless or declared bankrupt.
Of course, in the early part of my professional life, I was privileged to work in a ‘secure’ industry, and as long as payday is regular/periodic, we can empty our bank accounts to make room for the next pay.
Worse still, we can take on debt that we are confident our next paycheck (or the one after) can offset.
Different commentaries have portrayed multiple percentages of the average North American resident without an emergency fund, usually upwards of 50%.
Statistics have revealed that a scary 70% of the North American population do not have emergency funds that can cover 3-month expenses should the unexpected (job loss/ unable to work due to car crash or to care for a critically ill loved one).
It is not healthy to visualize bad scenarios as it impairs your positive outlook on life, but bad scenarios do occur, and they happen close to home. The best approach to this is to prepare for eventualities.
How Much is an Ideal Emergency Fund?
As with every other financial perspective, it depends. Your circumstance, lifestyle, and dependencies will have a significant impact on how much you need to save up in an emergency fund.
The Economy where you live:
You may want to understand the Economy you live in to determine your emergency fund. If the unemployment rate is high in your location and jobs are usually far between, you may consider a higher amount in an emergency fund.
You may have some particular situation that requires a different response to the generic amounts thrown around. Sometimes, some readers may have student debts raking up high interest or other forms of credit facility that they need to get rid of first. Getting rid of current debt is far preferable to keep some funds for a rainy day.
Your situation may be such that you have children, especially toddlers and kids. The need for an emergency fund is heightened in this case as they cannot fend for themselves. Children are your responsibility, and you need to prepare for their emergency fund as well.
The more dependencies you have, the higher the emergency fund you need to keep aside.
Your lifestyle may not be a significant factor. There’s such a thing as lifestyle inflation, where you adjust your spending to reflect a rise in your earnings. In the same vein, you may need to consider how well you can cope with a downsized wallet.
So, here is the magic word. Three – Six (3-6) months’ worth of living expenses should do for an emergency fund. It would help if you generally had living costs saved up as an emergency fund for this timeframe.
Living expenses are different from personal or lifestyle costs. Your living expenses include rent/mortgage, heating/electricity, essential internet/phone, home insurance, and basic meals.
Your lifestyle costs include cable TVs, Netflix/Amazon Prime, Gym membership and any form of subscription, eating out, taxi, and that kind of stuff. These do not form part of emergency funds, as you can live without these.
Recommended: Emergency Fund 102: How to Start an Emergency Fund
It is hard to dwell on negativities and have a good fortune smile on you all the time. The purpose of this post is to help you prepare for ‘life events’ outside your immediate control.
If you have this saving and a great opportunity comes, you are in an excellent position to grab it. It only takes away your emergency fund if a bad event occurs without significantly impacting your lifestyle.