Why do I need an emergency fund?

What is an emergency fund?

Emergency funds could be considered a necessity as far as financial security is concerned, since it gives you a back-up for if or when an emergency arises. The burden of paying sudden huge medical or dental bills, or an unexpected home or major car repair can you leave you in a financial hole that it's difficult to climb out of.

When you have no emergency fund, you may have to resort to adding more debt on to your credit card that can take several years to repay, all the while increasing because of the interest charges. Loan sharks and pay day loans are something else to avoid if you can.

So, by putting an extra thirty to fifty dollars or really, just however much you can spare every month, in an individual 'emergency savings account' you can rest a little bit easier knowing that your immediate bills will be covered in the event of a  job loss. An emergency fund will give you some breathing room and some room to negotiate in regards to sudden medical bills. Treat your emergency fund as another bill if you can, pay into it each month so it builds up to a reasonable amount as quickly as possible.

Your emergency fund will ideally be enough to cover three months worth of expenses. Think about weekly and monthly bills, the mortgage, insurance, gas for the car, groceries, the kids schooling. The goal is to create savings from budgeting your income, that give you a financial cushion when times get tight. What's important is that you should steadily put a certain amount of money aside, and only use it for real emergencies.

Your emergency fund is not an investment or your savings though, once you have saved up three months worth of expenses, open another account for long term savings. Again, if you can, pay into this every month. The success of your long term saving depends on placing whatever amount of money you can away constantly and steadily so your money is working for you at all times.

Where will the money for your emergency fund and savings come from if there's nothing leftover at the end of the week? You need a budget.
Budgeting is examining your weekly or monthly expenditure and putting aside money for anticipated and unanticipated future use. Within your budget you set can  up a goal to save a certain amount each pay day. Set saving for the emergency fund as your first goal.

When you realize where your money is being spent, then it will be easier to choose and make a decision where to trim down expenses. What you may notice when you start accounting for every penny is that it is very easy to just 'fritter' your money away. A coffee here, take-out on Friday, an ice-cream at the drive-thru.

The amount saved from budgeting can either go to your savings goal, emergency fund or both. Perhaps you already have debt that you're paying down. You may need to adjust your budget to continuing paying down your debt as well as paying into your emergency fund. While it's nice to have savings also, make debt and your emergency fund your priority.

So a budget will be an essential part of your plan for financial freedom, and a good way to make a start on it is to write down every little tiny thing that you spend money on.


More on budgeting to come.