Before you start saving or investing – make sure that you have an emergency fund, first!
What is an emergency fund?
Let’s face it – life is unpredictable (and frankly, kind of unfair!). It throws us challenges and unexpected costs. Expenses such as your car breaking down or losing your job. In order to safeguard yourself against such events, you need an emergency fund. An emergency fund is a pool of money set aside to cover any unexpected financial costs that you may encounter.
This pool of money is not the same as your cash savings and is not to be used towards your financial goals. It is very tempting to spend money that is just sitting there but these funds should not be touched and should only be used in emergencies. A credit card is also not an emergency fund as it can result in significant interest being added if you are unable to pay it off on time.
Why are emergency funds important?
Emergency funds are a great tool to prevent you from making poor financial decisions in a time of need. They give you freedom. Not having an emergency fund can mean having to take out a high-interest loan, sell investments at a loss or borrow money from family and friends. It can derail your financial journey and have a major setback on your goals. Furthermore, having extra cash can help pause or halt the issue temporarily until you find a sustainable situation – it allows for a bit more leeway. This is why it should be created first before you go ahead and start saving or investing.
How large should an emergency fund be?
Most experts recommend that your emergency fund be be 3 – 6 months of your living expenses. This may seem like a large number but, don’t be intimidated! Emergency funds can take some time to build. Start small with $50 and keep adding to this over time, you’ll be surprised how quickly it builds up! You can also check out my article on 5 Steps To Start Saving Money by clicking here.
Also, keep in mind that this figure heavily depends on your lifestyle and needs. For example, if you are responsible for dependents, you should be aiming for a larger emergency fund. If you’re a single person living at home, then a full 6 months of expenses may not be as necessary.
Where should an emergency fund be stored?
This money should be liquid and easy to access as soon as you need it. This is why I recommend leaving this money in a high-interest savings account rather than investing it. You could also leave it in your checking account however you may be tempted to spend it or miss out on potential investment returns.
In summary, an emergency fund is vital as it will grant you the freedom to avoid making poor financial decisions and be able to deal with times of crisis in a much better manner.
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