Saving For An Emergency

One of the greatest fears in the world of personal finance occurs when an emergency hits. When I say emergency, I am not talking about waiting until Christmas Eve to start your Christmas shopping, I mean a true emergency. The average U.S. family has little to no savings set aside to address a true financial emergency.

What is an emergency?

Before we go any further let’s define what a true financial emergency really is. In its most basic form, a financial emergency is something that you could not have planned for. For example:

• A tree limb coming down on top of your car in the worst storm of the year
• Your child tripping on the sidewalk and breaking a tooth
• The transmission on your car going out, two days after the warranty expired

I think you get the idea — and before you ask, I do not think your team making it to the Super Bowl and you ‘needing’ a new HDTV is an emergency.

What an emergency fund can do

When you have money set aside to address emergencies, you are able to focus on the situation and not worry about the financial crisis that has also occurred. You see, if you wake up with a tree limb in your living room, you have an home/insurance crisis. If you can’t pay for the deductible, you will also have a financial crisis. Most people should only be dealing with one crisis at a time. If you have an emergency fund, you can make better decisions on how to handle the crisis. Another thing that an emergency fund provides is options. If the transmission does go out, you can shop around for someone that has actually repaired a transmission and not simply leave it with the first shop that quoted you a price that fit in the available space on your credit card.

How big of an emergency should you plan for?

No one can plan for every emergency, but you can plan for most of them. If you are still trying to work your way out of debt, you want to have a small emergency fund, so you don’t borrow more money, going deeper in debt, if a ‘minor’ emergency occurs. That number will differ with each person/family, but should be somewhere around $1000-$2000. That should be enough to take care of most emergencies. If you do have an emergency, and you have to pull money out of your emergency fund, you will want to make sure you replace the amount you used as quickly as possible.

Once you have gotten out of debt, you will want to build your emergency fund so you can handle larger emergencies. For example, if you were to be laid off, you would likely need a little more than $2000 to cover you until you found another job. Most people agree that 3-6 months of expenses is a good number. That should allow you to take your time in finding your next job. You won’t be able to take a year long sabbatical but you will be able to systematically work through the process of firmly planting your foot on the next step up your career ladder.

An emergency fund is crucial if you are serious about getting out of debt. It is also one of the most important things you can do to help provide security for your family. When you have money set aside to address the unexpected, you aren’t nearly as afraid of what might be coming around the next bend.

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