Life Planning Basics: The Importance of an Emergency Fund

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by Jackie Waters

Special to the Financial Independence Hub

When setting up your financial life plan, it’s important to understand the absolute necessity of an emergency fund. Before you can start saving for what you want in your future, you have to save some for all the stuff you don’t want or expect to happen.

The main purpose of an emergency fund is to protect against life’s many contingencies. This includes, but is in no way limited to; job loss, medical co-pays, car troubles, home repairs, child expenses, and unexpected travel needs. Without an emergency fund, you’re forced to turn to other means to pay for things you simply can’t ignore. Many turn to credit cards, which increases personal debt and leaves people in insurmountable holes. It’s nearly impossible to invest in your future when you’re sitting under a pile of debt.

How much should be in your emergency fund?

Remember, an emergency fund isn’t a specific type of investment where you’ll gain interest or anything. You’re in charge of setting up a separate account to deposit funds. Once you do, many experts will tell you that three months worth of salary is a baseline emergency fund. That way, you’ll be prepared for the loss of a job or any minor to mid-level expense life throws at you. If you have dependents, you might want to think about somehow stashing six months of pay in your emergency fund.

If this sounds like too much, it’s important to know that anything counts. A basic fund of $500 or so is a good place to start, as that should cover a good amount of car and home expenses.

So, where should you set up the account?

“Your emergency fund should be liquid, meaning you need to keep it in a place where you can get to it easily and quickly. The best option is a simple checking account or money market account that comes with a debit card or checque-writing privileges. That way, you can pay that doctor or wrecker service with the swipe of a card or stroke of a pen,” says Dave Ramsey.

If your emergency fund is tied up somewhere you can’t touch it without penalties, it’s not really any good for emergencies. Make sure you have full access to any account where you stash for life’s unexpected events.

Having an emergency fund isn’t just about paying for unexpected life expenses. In order for you to safely make short, medium, or long-term investments, most financial professionals recommend that you have an emergency fund as the base of your investment “pyramid.”

Here’s how emergency funds tie directly into investing, according to Investopedia:

“Financial advisers view an investment strategy as a pyramid. A strong base is fundamentally important to support the levels of risk an investor bears as securities with varying levels of volatility layer over the foundation. Before an individual ventures into intermediate- or long-term investment vehicles, the establishment of an emergency fund is recommended as the first step toward creating stability and minimizing risk. Stashing three or even six months’ income in a highly liquid account, such as a money market, should preclude the purchase of any instrument that holds risk to principal or requires lock-in periods during which penalties are assessed for early withdrawal.”

So, before you can even think about making long term investments in things such as retirement or you kids’ college funds, you have to build a strong emergency fund. Then you can worry about things like your will and estate planning.

In the end, emergency funds provide more than just financial stability. They provide peace of mind. Living with no safety net is a stressful way to go about life. Constantly feeling like you’re one major crisis away from rock bottom causes anxiety that bleeds into every other part of your life.

Jackie Waters is a mother of four boys living on a three-acre Oregon farm. She runs hyper-tidy.com, providing advice on being  … Hyper Tidy!

 

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