Personal Finance

What is an Emergency Fund & Why Do You Need One?

Face life’s financial surprises with greater confidence by making sure you have a well-stocked emergency fund. This special stash of money helps you tackle unexpected bills without dipping into credit.

Check out this guide to emergency funds to learn more about what it is and why you need one.

What is an Emergency Fund?

An emergency fund is a specific kind of savings account that helps you when things go sideways. You can dip into it to cover unexpected bills or situations that make it hard to follow your budget.

Some examples include:

  • Flood damage
  • Taking your pet to the veterinarian
  • A sudden illness preventing you from working
  • Car repairs
  • A layoff or furlough

How is it Different from Other Savings?

An emergency fund is unlike other savings because of how you use it. When you save up for your child’s education or your retirement, you contribute to long-term investments. These accounts sit untouched earning interest over several years.

An emergency fund, on the other hand, is money you’re expected to access regularly. As a result, you need a special account that won’t penalize you for withdrawing your money.

How Much Do You Need in an Emergency Fund?

It depends on who you ask! A long-standing piece of advice is to save anywhere between three to six months’ worth of living expenses.

However, some financial experts think this is too low of a goal. TV pundit Suze Orman recommends bumping your emergency fund to a full year’s worth of expenses to cover serious emergencies.

David Bach, author of The Latte Factor, airs on the conservative side and saves two year’s worth of living expenses in his own emergency fund.

How Do You Start Saving?

With a goal like 12 months of expenses, you might be intimidated by the emergency fund.

If you’re daunted by your task, remember that it won’t sprout fully formed overnight. Whether you’re saving just three months or 12, saving this much will simply take time.

The trick is in looking at your budget to find where you can cut spending to increase savings. Unnecessary, variable expenses like takeout and entertainment costs are the easiest to slash from your budget, so pay close attention to them.

Another trick is to make saving a no-brainer. Automate these contributions to happen with every paycheque, rather than whenever you manage to remember to transfer cash.

What to Do if Your Emergency Falls Short?

Ideally, your emergency fund will cover every emergency you face. But part of good money management is considering the possibility it may fail.

Recognizing this will help you find a Plan B faster. If you face a series of bills or repairs you can’t afford, a personal loan or line of credit gets you what you need.

If you’re in a tight spot, shop around for the best option. Sometimes, the most obvious choice isn’t the best choice. Some of the biggest household names in the financial world apply the highest financing charges and interest rates on their loans.

Compare commercial banks with banking alternatives like a local credit union. An easy credit union loan calculator is an excellent tool when deciding between the Big Banks and other alternatives.

Bottom Line: Start Saving for a Rainy Day!

You may not be able to predict where you’ll be in two, five, or ten years’ time. But one thing’s for sure: you’ll face a few hiccoughs along the way.

That’s normal!

An emergency fund helps you be prepared for whatever comes your way — whether it’s an unexpected illness or an unavoidable home renovation. Start saving now, so you’ll be ready later.