The Importance of an Emergency Fund

Written by: Philip Swann, The Henderson Group

An emergency fund is a reserve of money that is set aside to cover the financial surprises life throws your way. These unexpected events can be stressful and costly.

Some of the top emergencies to expect are:

  • Job loss
  • Medical or dental emergency
  • Major unexpected auto repairs such as a new engine or transmission
  • Failure of a major home appliance – furnace stops working or the hot water tank goes out
  • Large, unexpected home repairs or deductibles. A tree falls on your home, your car, or your basement floods. Home repairs are vital to address immediately since your home is often your largest asset.
  • Unplanned travel expense, as a result of a family emergency or death.

Benefits of maintaining an emergency fund

It helps keep stress at bay.
No surprise that when an emergency occurs, and it will, it threatens your financial well-being and causes you (or your spouse’s) stress level to rise. If you currently don’t maintain an emergency fund, you’re living without a safety net. You are living on a financial cliff, hoping to get by without experiencing life’s surprises.
Your emergency fund gives you the confidence to handle any of life’s unexpected events without adding money worries to your list.
It keeps you from spending on a whim.
We know that you have heard the saying “out of sight, out of mind.” That is the best way to maintain your emergency fund. If the cash is only as far away as your debit card, you might be tempted to use it for something silly like a designer purse or big screen television, neither of which are considered emergencies.
By keeping the money out of your immediate reach you will be less likely to spend it on a whim.
By keeping it in a separate account, you’ll know exactly how much you have and how much you may still need to save.
It keeps you from making bad financial decisions.
You may have other ways to quickly access cash, such as borrowing, but at what cost? Interest, fees, and penalties are some of the drawbacks.
How much should be in your emergency fund?
You should have 3 to 6 months worth of your monthly expenses.
Where should you keep your emergency fund?
Emergency fund investments need to be guaranteed or at least very low-risk. You need to be satisfied with low-interest bearing accounts. Checking, savings and money market accounts are appropriate choices.
Did you know?
54% of people in the United States don’t have a rainy day fund that would cover 3 months of expenses.
Source: FINRA Investor Education Foundation National Financial Capability Study, 2015.
Final Word
An emergency fund can mean the difference between financial failure and financial success. Not only must you develop the discipline to build one, but an emergency fund will prepare you for life’s unexpected setbacks and reduce your dependence on borrowing money, most likely at high interest rates.