What is an emergency fund you ask? Essentially it is a liquid cash account easily accessible in case of financial emergency.
What qualifies as an emergency
Let’s discuss a little about what qualifies as an emergency and what doesn’t.
- You lose your job
- You get disabled short term (most disability insurance kicks in at 90 days)
- Health issues/bills for you or someone in your family
- The fridge or other appliance, or car breaks down
- Credit card debt
- Black Friday deals
- New iPhone comes out
- Expensive vacation
- Luxury car
If you lose your job, you still have monthly expenses you need to pay. Having an emergency fund to pay for those expenses is vital in staying out of debt and not getting off the track to your financial goals. Similarly, if you get hurt and cannot work for a couple months, your disability insurance likely won’t help. Having an emergency fund to get you through that time is very important to not go into debt.
Early in your career, health expenses, or a car or appliance breaking down can be an emergency. Having a few thousand dollars in an emergency fund to take care of it rather than having to take out a loan or use a credit card is essential. Later in your career you may have sinking funds to pay for some of these things or maybe even be able to cash flow them.
Also, consumptions items such as nice cars, vacations, or the newest phone is not an emergency. Don’t use credit cards or loans for these things. You must be able to pay for these things in cash if you want them. And not the cash from your emergency fund. You must have saved for these in other sinking funds or be able to cash flow them without violating the rule of destroying your student loans in no more than 5 years, and saving at least 20% of your GROSS income for
retirement financial independence.
When to have an Emergency Fund
Right now if you haven’t yet. Even someone in dental/medical or other professional school should try to put away a few thousand dollars in case of emergency. Too many times students use credit cards for these emergencies. Then they use it more. Then they have a huge credit card debt and instead of taking care of the emergency, they just created a new emergency (yes credit card debt is an emergency).
As you get later in your career, your emergency fund needs will grow as your expenses grow. However, your income will grow and so it may be easier to fund it. Then as you reach financial independence, you will still likely want to have a fund liquid for emergencies so that you don’t have to dip more into your investments and violate the 4% rule.
How much should you have in an emergency fund
The rule of thumb is 3-6 months expenses. When you are a student at least try to have a couple thousand dollars. Again, as your expenses grow, so will your need for more money in an emergency fund. I am more conservative and tend to lean towards the 6 month rule. I really want to be safe in an emergency situation. You don’t want to over do it though because that money in an emergency fund won’t be growing at the rate as it would be in the stock market. You will not be able to reach your financial goals keeping all or most of your money in cash. you need to invest to reach these goals.
Also, recognize the emergency. Credit cared debt for instance is an emergency. So if you have credit card debt, don’t fund an emergency account. You already have the emergency. Pay off that debt ASAP and then start funding the emergency fund again. Remember, it is 3-6 months of essential expenses. If there are expenses you can get rid of (Netflix, or other entertainment subscriptions) in an emergency situation, then do it.
Lower interest debt isn’t as much of an emergency. While you are paying off your student loan I would still recommend having 3-6 months in an emergency fund. However, make sure you are not just making minimum payments to your student loans. Destroy them within 5 years of graduation.
Where to keep your Emergncy fund
Here are the three most important rules of where to keep it:
- Safe place: This means don’t keep it under your mattress, or in the stock market, or in bitcoin. You may want to have some cash on hand at home, but I wouldn’t do too much. It can get lost, stolen, or destroyed in a fire/flood.
- In an account that’s liquid: Your emergency fund being tied up in a rental property or such isn’t much of an emergency fund. You need to be able to get it ASAP.
- An account it will grow in (at least a little): Granted it will likely grown more in the stock market but that violates rule #1. There are high interest savings accounts that are ideal. For example I use Ally right now. I think the interest rate is 1.7%. It was over 2% a while ago. There are a lot of other options, however what I mean is don’t keep it in a regular bank’s saving account where it earns 0.1%. That is just throwing money away.
The most important thing is to make sure you have an emergency fund. Get something started now if you haven’t. Even if you are a student, have a couple thousand dollars saved in an emergency fund. If you are working in your career, make sure you have at least 3-6 months in an emergency fund. Make sure you know what is and isn’t an emergency. Keep it is a safe place that is liquid and where it will grow at least a little.
If you do these things, you will be all set in an emergency situation and won’t be derailed on your path to becoming financially independent and debt free.
-Debt Free DDS
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*Nothing on my website is professional or legal advice. I am only sharing information that I have learned and it may or may not be accurate. I am not liable for any problems you may have by following this advice. Please do further research and get professional and/or legal advice about any of these topics. This post likely contains affiliate links. This site could be paid for clicks or purchases made through these links.
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