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What is an emergency fund and why do you need one?

What is an emergency fund and why do you need one?
Posted at 10:54 AM, Jan 21, 2020
and last updated 2020-01-21 18:05:40-05

You may find yourself asking, what is an emergency fund and why do you need one?

Carl Carlson, CEO of Carlson Financial, said simply put, an emergency fund is for unplanned expenses or loss of income.

You might have a watertight budget and are good at sticking to it, but if something unexpected comes up, even the best laid plans might be ruined. Some examples might be a costly repair on your house, needing a new car, medical bills. Maybe all of your expenses stay the same, but you find yourself suddenly without work or unable to work. Will you be able to cover your bills?

A general rule of thumb is that you should have three, six or nine months worth of expenses set aside. To a lot of us, that can make a big difference in how much we need to save.

Carlson said there are a lot of factors that play into this, one easy consideration is, are you married and/or a dual income household? If so, the likelihood that you lose both sources of income at the same time is low, so someone in this scenario may need a smaller cushion than a single income household. If you take the highest income out of the equation, how much of a shortfall will you have each month?

For someone who has already made their budget, that should be easy enough to figure out. Owning a home is a big factor. Most people who have owned a home for any length of time will probably tell you, it can get expensive very quickly. If there’s something you know you might need replace or repair in the near future, save up for that as soon as you can. If not, figure out what amount you would like to have available just in case. If you don’t own a home, you can probably get away with having less in the rainy day fun.

Insurance might impact the amount you need to have saved, Carlson said. A lot of these risks are insurable, but there is almost always going to be some out of pocket cost. Think about your auto, health, home and disability coverage and what would be the most you might have to pay out of pocket. For example, if you’re on a high deductible health plan, you might have to pay over $7,000 out of pocket before insurance will contribute anything. What if this health issue has also left you unable to work? Do you have disability insurance, and if so, when is the soonest you could collect on it?

It requires a little bit of thinking, but it’s thinking you’ll be glad you did if any of these things happen.

The majority of Americans don’t have anything saved for these rainy day scenarios – don’t be one of them! Put this at the top of your resolution list for the New Year.