By Jennifer Micieli, Financial Expert at Credit Karma
See if you can complete this financial exercise in less than 60 seconds:
How much do you need to live off of each month? $___
Multiply that amount by three (x3).
What number did you get? $___
Let's discuss why this number is valuable.
Proactive Planning
Imagine you had that amount of money in an account that you didn't touch except for when you were responsible for an unexpected financial cost such as a parking ticket, surprise medical bill, unanticipated home repair or a sudden drop in your income. It'd be a great tool to rescue you from a potential financial crisis. That is the value of an emergency fund.
We all know unforeseen things can happen, but not everyone is prepared to pay for these sudden costs. Make things easier on yourself and proactively prepare for surprise financial expenses. While you may be tempted to use credit to bail yourself out, this can create issues for your credit health if you end up with a high credit balance or aren't able to make your payments. Planning for the future can help you avoid that altogether. With all this in mind, let's consider a few different factors to keep in mind when planning for your emergency fund.
Factors to Consider
Three months of savings is a great general goal to strive toward, but how much you'll want to save for your unique situation depends on a variety of factors:
- Stability of Income - If your primary source of income is less reliable, like money that comes from freelance work, you may want to consider saving six or even nine to twelve months of savings.
- Tolerance For Risk - This is your personal preference for how long you'd want to be covered for. The less you have saved up, the more risk you take.
- Insurance Deductibles - If you have insurance policies that have a deductible, or an amount you need to pay out of pocket before your insurance coverage kicks in, you can plan to have that amount available in your emergency fund.
- Higher Risk for Unexpected Expenses - If you have the potential for significant medical needs, live in a city where parking fines are commonplace or own an unreliable car that could need unexpected repairs, you may want to factor those possible situations into how much you save.
- Space You Have In Your Budget - This determines how much you can plan to save and how much you will be able to save. If you have a lot of fixed expenses, or set expenses that you're required to pay, you won't have as much flexibility as someone who has more discretionary expenses.
Where you stand on each of these factors can have a significant impact on how fast you'll be able to build up your emergency fund and how much you should save. Now let's review how you can plan and grow your emergency fund.
Setting Yourself Up for Success
The exercise above is a good estimation of how much you may need to save, but if that amount seems unachievable, you can always start with the amount you'd need to live off of for one month and work up from there. Simply starting the habit of saving will be key to your success.
If you're having trouble setting aside money for your emergency fund, try paying yourself first -- set up automatic transfers as one of the first things that happen once you receive income. Using this system, you may be more likely to succeed in building it up to your goal. This account should be kept fairly liquid and without too many restrictions, so a savings account/money market account would be a good option to consider.
Bottom Line
Be prepared for the unexpected by committing to the goal of starting and funding an emergency fund. It can be a helpful resource to help you pay for surprise financial costs when you need it most. Start with what you are able to do right now and work your way up. Once you get going, you'll soon be more financially prepared for life's surprises.
This content is for entertainment and information purposes only. The opinions expressed in this piece are those of the authors themselves, and not necessarily Credit Karma, its affiliates, or its business partners. Efforts have been made to present information that is up to date and accurate at the time of its initial publication. However, neither the author nor Credit Karma make any guarantees about the accuracy or completeness of the information provided.
About the Author: Jennifer Micieli, CFP® is Credit Karma's Financial Expert. Prior to her start in November 2014, Jennifer worked as a financial planner for five years. She spends her free time running races, organizing anything in sight, devouring sour candy and sleeping in.
