How much is enough for an emergency fund, you ask?
Well, that's a highly debated topic. The answer is (as always), it DEPENDS. Before I get into how much is enough, let's backtrack and talk a little about the purpose of an emergency fund.
Webster's dictionary says that an emergency fund is “an unforeseen combination of circumstances or the resulting state that calls for immediate action.” That “call for action” is the second part of this topic, FUND.
So, what kind of emergencies are we talking about?
Here are four common emergencies that come to mind:
1-You lose your income. This one is all too familiar to Americans in this economy. When you lose your job, what do you do? Most take out unemployment benefits.
Unfortunately, the government's unemployment check will barely cover the food bill. To make up the difference, an emergency fund would help ease the strain of unemployment while you search for a new job.
2-Unexpected car repairs. How many times have you heard people complaining about unexpected auto repairs? Things like transmission failures, blown head gaskets, and serious engine damage.
These problems can cost a pretty penny and most families don't factor this into their monthly budget. So when a car repair is needed, where does the money come from?
An emergency fund would be helpful. You could use emergency funds for the car repair and your monthly family budget would be unscathed.
3-Home repairs. Having lived with my parents for 22 years, I'm all too familiar with home repairs. Septic tanks, water heaters, plumbing leaks, upgrading windows, and air handler units come to mind.
These are not cheap to replace by any means. And what if your house floods? And what if a fire burns everything you own? These are issues you need to plan in advance for. Part of planning in advance is having an adequate emergency fund.
These are issues you need to plan in advance for. Part of planning in advance is having an adequate emergency fund. Some people opt to enroll in a home warranty plan to cover their costs in the event of an emergency repair or replacement.
4-Medical problems. We all know how expensive health insurance is. And even then, almost all insurance plans don't cover 100% of major procedures and medicine prescriptions.
Oh, have I mentioned medical bills are one of the top reasons why Americans file for bankruptcy? Step one is to have great health insurance. Step two is to have an emergency fund on hand. Step three is to try to stay healthy in the first place!
Now, how much is enough for an emergency fund?
This will be up to the individual and unique circumstances. Many of you know of Dave Ramsey. He created Financial Peace University. His program recommends a 6-month emergency fund.
I tend to agree with him. Some financial experts recommend more than that but most agree that 6 months is a nice cushion to have if an emergency arises.
A 6-month emergency fund should include all typical expenses for a 6-month period of time. These things include but are not limited to: groceries, rent, gas, insurance, etc…
So, where should you place your emergency funds?
Well, I want to point out that I think it's better to pay off your high-interest debt before you save for an emergency fund. It's as clear-cut as that. If you have credit card debt, pay it off first.
The great thing about credit cards is that the credit remains available to you. So pay off the card, then you can use it in place of the emergency money if need be. Why pay interest on money in one account, only to have it sit making no interest in another?
I also feel like you can use some of your emergency funds to purchase a house if you have accessible credit at your disposal (in form of credit cards). I really believe owning a home is a life-changing investment, and the sooner you do it the better.
If you have a few month's worths of expenses as available credit, Perhaps use up to 50-75% of your emergency fund toward a downpayment. Depending on how much you put down, you may be able to get a home equity line of credit so you can access some of that equity.
Otherwise, it's not a safe bet to invest your emergency funds in the stock market. It's tempting I know, but in the short term, the stock market can be pretty volatile…so if you have to sell in a pinch you could lose a good portion of it.
Best bet is to put it in a high yield savings account (not a CD)
Thanks for reading. Happy saving.