Emergency Funds: The Basics

Joe Bradford

| 04/21/2015

Starting an Emergency Fund

An emergency fund is an amount of money that you save for hard times. Out of sight and out of mind, you don’t use it until you absolutely, positively need it. Many advocate for at least $1000 in savings to be held in an easily accessible location (i.e. in cash or a savings account). While $1000 is a frugal choice, I’d say you probably want a little more than that. If you can save around $3000 dollars for your emergency fund, it will go a long way during hard times.

I recommend $3000 because most unexpected expenses will take a large chunk out of your pocket. Think about your last major car repair, it was probably on the low end of $500 dollars and the high end of $2000. Think about medical bills. Sometimes your insurance won’t kick in until you’ve met your deductible, i.e. the minimum you pay out of pocket in order to have a large portion of your bill covered by the insurance company. Depending on your health insurance plan, your deductible can be anywhere from $1000 to $3000 dollars. What if you had to go to an emergency room for treatment? The costs would sky rocket.

After your Emergency Fund

But what about after you’ve saved that initial 1k (or 3k)? In addition to your emergency fund, you’ll want a “Disaster Fund.” Why? Because while unexpected costs can sideline you if you have a job, those same costs can be disastrous if you lose your job or are disabled.

Generally you’ll want to save about 10% of what you make monthly for your Disaster Fund. Take this 10%, add it to your savings, and act like it is not there. Let’s say you take home 5k a month. 10% of that will be $500 dollars. How long do you save 10% for?

Let’s look at two possible scenarios that could play out in your life:

1) You lose your job.

2) You start your own business.

While the second isn’t really a disaster, you’ll probably be bootstrapping it for a while. How do you maintain an adequate lifestyle when you’re paying for everything without positive earnings? This is where the disaster fund comes in. If you’ve lost your job, it will take a minute before you get another. If you start a business, it will take a minute before you have a positive cash flow.

Most money specialists will tell you to have at least 6 months of your expenses in savings for a Disaster Fund. So if your take home pay is 5k a month, but you only need 3k of it a month to pay for all your expenses, then you’ll need to save 3k x 6 = $18,000. If you’re saving 10%, you’ll cap off your disaster fund in about 36 months or 3 years. What if you increase your savings until you get to that point? Instead of saving 10% when starting your fund, you invest 20%? You’d be saving 1k a month, and that would cut your savings time for the disaster fund in half to 18 month or 1 ½ years.

After you’ve met your 6 months of expenses in your Disaster Fund, you can scale down your savings percentage to something lower. If you are comfortable with where it is, start to invest the same amount you were saving. See some of our article on investments to get a better idea of what to do in that situation.

Bottom line: Start today to secure an emergency fund, then a disaster fund.

The Prophet ? said “If I had mount Uhud in gold in my home I’d give it all away in three nights, except for some money that I’d save to pay off debts.”


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