Do you need an emergency fund?
I previously wrote about how to make more money from your emergency fund, but I decided to take a step back and explain the purpose for an emergency fund. I used to think of an emergency fund as robbing myself. It was essentially the same as paying taxes in my mind. All I knew was that money was coming out of my pocket going somewhere else. Obviously,
this was completely untrue, but it was how I felt at the time. Thankfully, I learned how beneficial an emergency fund is to my long-term financial well being.
If you had a $500 unexpected expense come up right now, how would you pay for it?
If you could come up with the money and NOT have to use a credit card, you are doing much better than most Americans. Life happens, and unexpected expenses are to be EXPECTED. If you prepare for them you will be able to better avoid a financial crisis, if not, that is what they call “learning the hard way.” Lets say (for sake of discussion) that emergencies happen, on average, once every year (everyone’s definition “emergency” is different, so the frequency may be more or less for you) and cost an average of $500. The truth is that just about everyone does have an emergency fund. The only difference is that they are either earning interest or paying interest.
Paying Interest
Let’s look at the typical American response to an emergency (costing our assumed average of $500). Emergency #1 happens and they don’t have an emergency fund, so they borrow the $500 from a credit card (17.5%). This solves the short term problem of paying for the emergency, but now they have to start making payments to the credit card company. Things are tough enough, they didn’t have the money to pay for Emergency #1 to begin with, now they have to try to find $20 each month to pay the minimum payment and to add insult to your injury the credit card company is going to charge them a huge percentage rate on the amount borrowed. When emergency #2 happens they will likely be:
- Still trying to pay for Emergency #1 (they will still owe $350)
- They will still be paying the interest to the credit card for Emergency #1
- It is probable that they were not able to save up for emergency #2, since they were still spending extra money to pay for emergency #1, therefore they will have to borrow again to pay for Emergency #2
- Now they are paying back both Emergency #1 and #2 ($850 total), paying interest on both amounts borrowed, and in even a more difficult place to start saving for emergency #3 since their minimum payment increased to $35.
This is only the beginning of the vicious cycle: it only gets worse from here. You can imagine what their financial lives will look like in 5 or 10 years.
The prudent see danger and take refuge, but the simple keep going and suffer for it. -Proverbs 27:12 (NIV)
Earning Interest
Let’s assume you are one of the few (but extremely wise) Americans who decided to start an emergency fund (because some equally wise
blogger told you it was a good idea). If you were able to find that $50 a month now (before emergency #1 happens) and start saving it to prepare for it, you would likely (and hopefully) be here when emergency #1 happened:
- Have more than enough money saved for emergency #1 ($600 saved)
- Will have earned interest ($15) on your savings which will have just increased the size of your savings even more ($615)
- You will have a head-start saving for emergency #2, because you saved more than enough for emergency #1 ($615-$500=$115)
- You will be earning interest on what you still have saved after paying for emergency #1 ($115), and you will be saving and earning interest on the amount you are saving for emergency #2.
When emergency #2 rolls around you will have $735 saved up to pay for the $500 emergency. Just repeat the process again and again and you can imagine what this will look like after 5 or 10 years.
How much should I put in my emergency fund?
I think $50 a month is a good ballpark to get started for many people. Obviously if you are making six figures, you may want to increase the amount or if you are making four figures, that may be too much. If you are having trouble finding the extra money, you may need to quit spending everything you make or learn what to do with a raise.
Where do I start an emergency fund?
I recommend ING Direct for a high yielding savings account. The most important part is getting started, no matter where it is. But, look for something that you can direct deposit into so you do NOT have to think about it.
Before I get a bunch of comments arguing about the frequency of emergencies or how much the average emergency costs, let me just say these assumptions are based on how things have worked out for me. I am sure some will have “emergencies” every 6 months and some every 4 years, but I am basing this off averages in my life. My intention is only to show the long-term benefit of building an emergency fund rather than using a credit card.


{ 15 trackbacks }
{ 16 comments… read them below or add one }
Although I agree. In an actual emergency, I find it easier to pay for it with a credit card, and then withdraw the money from my emergency savings fund later. This is especially the case if I don’t know how much the emergency will cost in total before its over.
Very well outlined. I just finished funding my emergency fund to $1000 last month. I have such a different outlook on my finances now! I was finally able to ditch the last credit card I was keeping around the house (for emergencies).
And to someone who is just getting started- absolutely get started now. I started with $50. Just give it some time.
Very good thoughts, and I agree totally with the cycle you get caught in without one. My husband and I have/are living that vicious cycle of emergency after emergency and still paying for it. I am in the process of establishing an emergency fund at ING, with $70 per month for the time being. If the good Lord willing and the creek don’t rise, I should have close to $2000 by this time next year.
@plonkee
I agree, IF you have enough discipline to pay it off each month, that is a good idea.
@FinanceandFat
Isn’t it a great feeling? I feel so liberated, just by having an emergency fund built up!
@Michelle
Awesome! That is good to hear and when you hit your goal, check out the post I mentioned at the top about making more money from your E-Fund – the method I used helped me build it a lot faster than I thought I could
We funded our first emergency fund earlier this year, $1000. We threw everything we had into it and we were able to do it in about a month. Oddly enough since we’ve funded it we’ve had a few car emergencies come up but haven’t had to touch the emergency fund. Before having the emergency fund we would have just charged car repairs. (we are not charging anything anymore) but it is SUCH an awesome feeling knowing we have that money there in case something comes up.
@Erin
Way to go! You are right, it is such a good feeling to know that the money is sitting there just in case…
I like the ING account for saving $ for an emergency fund, but when I had to take $ out it took forever. I am trying to establish a stash of cash for true emergencies. I guess it depends on what emergency you are planning for.
If you had a $500 unexpected expense come up right now, how would you pay for it?
——————————————
I would have no way to pay it. What happens then?
I recenty lost my dad this new year. And it coas all our money for bills. Loans and credit cards bills and everyday bills are butting me and my wife into a financial debt and behind on all debts we owe. I need a financial merrical!!! HELP!!!!! CONSERNED BROTHER IN THE LORD JESUS CHRIST
@Jeff
I am going to email you about this since it is a fairly personal matter…
I am a private money lender,i am based here in Italy, if you need a loan to start a small business or a personal loan to pay of bills then contact
me now.The maximum amount i give out is €1,000,000.00 , why the mimimum amount as loan is €5,000.00
Interested Persons should contact me on (deco_macrofinance@hotmail.com)
Regards,
Mr deco Danty
MY NAME IS MR DECO DANTY, I AM A CERTIFIED MONEY LENDER . I AM WILLING TO ASSIST ANY TRUST WORTHY PERSON IN GETTING A LOAN SO IF INTERESTED CONTACT ME .ON MY EMAIL ADDRESS (deco_macrofinance@hotmail.com)
Regards,
Mr deco Danty
Our firm know is a reputable and well known firm. We give out loans at a very cheap rate . You can contact us today for that loan you need with the email contact: (deco_macrofinance@hotmail.com)
Regards,
Mr deco Danty
we offer loans for the individual we can assist even with bad credits,estate loans,company loans and loans for business
CONTACT OUR MANAGEMENT
VIA THIS EMAIL. (deco_macrofinance@hotmail.com)
Regards,
Mr deco Danty
I give out loan to people who are interested in getting the loan. I give for 3% , and you state the amount needed. I can be contacted via e-mail (deco_macrofinance@hotmail.com)
Regards,
Mr deco Danty
WE RENDER LOANS AT LEASE. DO YOU NEED A LOAN? DO YOU HAVE MONEY PROBLEMS? DO YOU REQUEST A BUSINESS OR A PERSONAL LOANS? DO YOU NEED FINANCIAL SURPPORT? WHAT YOUR STORY? CONTACT US NOW FOR A LOAN OFFER, OUR LOAN SERVICES IS AT AN INTEREST RATE OF 0.2% AND A WELL CALCULATED LOAN TERMS. (deco_macrofinance@hotmail.com)
Regards,
Mr deco Danty
I’ve received an offer on a loan from Dr. Deco Danty and want to konw if he is for real or an internet scam artist? I see he is listed on your site, can you truly help me to determine this. Our company is a Christian owned Medical Device company that has new “breakthrough technology” that will change the lives of the disabled and elderly. We need a Rightous and Truthful Answer Please. Thank you and God Bless!
I am a theological teacher.I came from muslim background.At first,i got the Good News & then I studied life & ministry of Jesus.I also studied islamic history & culture.Then finally,I accepted Christ as my savior.From 1995-2008 I studied Diploma of theology from Bangladesh,Bachelor of theology & bachelor of Christian Studies from Serampore University India.Now i am teaching in several Bible Training institutes in Dhaka,Bangladesh.My vision is Teaching & Preaching according to Mathew 28:18-20.Specially,I want to establish a Bible Training Center for the mejority group in
our country(Muslim people).I need help on the both side the Paryer & the Financial
support.The main reason is,in Bangladesh we have several Bible Training Centers
but just only two Centers are going on for Muslims.So please help me to establish a Bible Training Center. In John 4:35-36 Jesus saysThat”Open your eyes & look at the fields they are ripe for hervest.Even now the reaper draws his wages,even now he hervests the crop for eternal life”.
I love the idea of an emergency fund, but I have a quick question? Is it better to build an emergency fund or put the money towards debit reduction? I am getting an extra paycheck this month (I get one every six months) and I was wondering if it would be better to put it towards paying off a credit card or into my emergency fund. My current emergency fund has less then $100 in it (I just started building one), so I would like to get it built up. However, my interest on my credit card is going to be increasing in a few months so I would love to get it paid down. What are your thoughts?
Jennifer, I like Dave Ramsey’s approach. He suggests first building up a $1000 emergency fund and then start paying down the debts. The $1000 should provide a buffer for emergencies that will prevent you from having to use credit cards if the car breaks down or something similar
Dear Mr. Deco!
I write what he did to me
everywhere, wherever I see the name
Good for you
Peter