Building financial security means sticking to a smart strategy and thinking ahead. Success comes from spending less than you earn, investing wisely and protecting against unforeseen challenges, and to be truly prepared, you should probably have an emergency fund. Here’s how and why an emergency fund could save the day, no matter your situation or income level.
1. Why an emergency fund?
The point of an emergency fund is to cover unexpected events that could put you into long-term debt. It may be tempting to invest this money, but don't. Your emergency fund should be kept as cash so that when you need it you don't have to waste time selling shares or converting other assets.
2. How much should you save?
First, total up your monthly household expenses. Don't include discretionary spending categories like entertainment or personal shopping. Instead, add up necessities like rent, utilities, gas, groceries and insurance. Now, take that number and multiply it by 3, 6, or 9 depending on how secure your current income situation is.
If you're a salaried employee at a stable company, three months' worth of essential expenses might be enough. However, if you're a freelancer, you may be better off aiming for six to nine months' worth of savings. Think about your personal or family situation and be realistic about what expenses you would need to pay.
3. When should you spend it?
Be disciplined and save your emergency fund for true emergencies, such as a large medical bill or a layoff. It can be tempting to use this money for non-emergency purchases but you don't want to whittle away at your emergency fund. You want to have enough of a financial reserve for when you truly need it.
Planning to have financial reserves in case of emergency will help give you peace of mind.