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The core principle behind any emergency fund is having an account with money that is generally untouched and will only be used when it’s most needed. Such emergencies can include any major unexpected expense, but often emergency funds are used during times of illness to cover medical bills, or when a person loses their job. In any of these cases, having money set aside can provide peace of mind when you need it most, during an already stressful situation.
Financial stress can take a big toll on your personal life and the lives of your family. Many relationship problems arise whenever there are issues with finances, and if you don’t have a cushion set in place to fall back on, then things will only get worse. Having an emergency fund as a cushion will ensure that you stay out of debt whenever that unexpected expense suddenly shows up.
It’s wonderful to know you have your expenses covered in the event of an emergency, because the next alternative for many faced with the loss of their income, is to rely on their credit cards, which leads to difficulty down the road. Once they finally do find a new job, then they might find themselves stuck with months or years of debt piled up which, considering the interest rates on credit cards, are a much tougher burden than regular saving would have been.
To figure out how much money you should set aside for this fund, you should first realize that it has a great deal to do with your particular situation. A good place to start would be to calculate anywhere from two to five months of your total living expenses. Once you have accumulated enough to survive for that long, then you can relax and slowly work your way up from there. The two to five months is a base value, but if you carry a significant amount of debt, or have children and other responsibilities to cover, then that amount should be substantially higher.
Another factor in planning your emergency fund is job security. Two to five months worth of savings is great if you are a highly skilled worker with a demand for your services, but if you are uncertain about your job prospects after a layoff, then you should take into account the condition of the current job market. People who lose their jobs today, for any circumstances, are often out of work for a much longer time period than in prior years. For this reason, financial professionals recommend that the majority of people store anywhere from 10 to 12 months worth of savings.
A simple savings account is the quickest and easiest way to begin working towards building a secure emergency fund. Savings accounts are usually free, and provide convenient access to your money. If you have more than a few months’ expenses saved, consider short term CDs for a portion of your account, which will pay a little more interest on your savings. But since the idea is that your funds should be accessible at a moment’s notice, be sure to keep enough money in a liquid account with no withdrawal penalties.
It’s ultimately up to you when to put your emergency fund to use. There are lots of obvious things that you should avoid tapping into your fund for, such as vacations, new clothes, jewelry and other luxuries. Just because you receive an unexpected bill doesn’t necessarily mean that you should automatically turn to your savings account to cover it. Assess the situation and make a wise decision after careful thought.
If you were to turn to your emergency fund every time a dentist bill or insurance payment showed up in your mailbox, then you will rapidly run it into extinction. Bills like these are important, but paying for them should be planned as part of your regular budget. Remember, the emergency fund is for unexpected expenses!
Nevertheless if you ever run into large difficult medical bills, lose your job, or have important home and car repairs; then it’s fine to tap into your fund. Create a personal blueprint for times when it’s okay and when it’s not good to take money out of your savings account. Ultimately, you must remember that this is your money and it’s there for you to use when times get tough.