Over and over again, I’ve referred to the value of an emergency fund without really explaining what it is and how you can get one. To put it simply, an emergency fund is the most valuable thing you can have because it protects you from the unforeseen things that can demolish all of your financial planning and throw you into debt.
What exactly is an emergency fund?
An emergency fund is a cash reserve that you keep in a safe place and use only for emergencies. This cash reserve should be as liquid as possible (a high-yield online savings account is just about perfect) and should contain at least $1,000 (at first) and eventually six to twelve months of your household’s take-home salary (eventually).
The only reason you ever tap into your emergency fund is if a situation arises that causes your monthly budget to not balance. Ideally, your monthly budget should have enough flex in it to handle things like a blown tire, but sometimes things happen like a dead transmission or a blown hot water heater and we simply need more cash than our budget can afford. This is when we turn to the emergency fund; it should have enough cash there to fix the emergency and then be replenished during the calmer times.
Sounds great, but I can’t afford one!
Can you spare $1 a day? Then you can get started with an emergency fund. With just $1 a day, you can have an emergency fund of almost $400 by the end of the year and thus reach the $1,000 mark in about two and a half years.
Most of us can skip a take-out meal or two, or maybe skip out on dining out or not go on a weekend spending spree, and come up with $10 a day. If you can do that, you can hit $1,000 by the middle of April and have almost four grand in the emergency fund by the end of the year. $4,000 can help out with many financial crises.
How I used an emergency fund: an example
I used to think this was overkill, but I started an emergency fund anyway at the insistence of many, many personal finance writers. I started slowly, putting roughly $7.50 a day into it. In three months, I had about $800 stored away.
What happened? The brakes died in my truck. It turned out that the brake pads on my truck were actually crumbling – it was not something I had expected to happen. The bill? $700. Normally, this would have made me utterly sick and kept me up at night, but since I’d cut down on my latte and sandwich intake (not even eliminating it, just cutting down), I was able to calmly write a check to cover the whole thing.
That night, I bumped my daily emergency fund imput up to about $20 a day, and it’s gone up from there. It’s a lot easier to give up your daily take-out and your silly shopping trips if you know you’re making yourself safe from such disasters – and you’ve actually seen it at work.
One other note: I also use my own emergency fund as the starting-off point for my investments. I contribute heavily to my emergency fund on a weekly basis and make sure that it stays above a certain level that I’m comfortable with. What do I do with the excess? I deposit it into other investments, such as my non-retirement mutual fund (which my wife and I are starting to call the “dream fund”).