An essential step to financial security is building an emergency fund. Whether you’re a young professional who’s just starting out in life or a middle-aged individual about to enter retirement, a fund for the rainy days is essential to have.
Most experts and financial articles would suggest having at least money in this fund that’s equivalent to three to six times your monthly income. However, this is just a rule of thumb. There’s no set standard on how big your emergency fund should be, because the right size will be dependent on your situation and needs.
When sizing your emergency fund, here are factors you need to consider.
The purpose of an emergency fund is to provide a financial source you can tap when you face an unexpected event such as unemployment or sickness. That’s why you need to know just how much you need to cover all your expenses in a month.
When you have a budget in place, it would be easier for you to determine how much you need to put in your emergency fund. Go over your budget and sort your expenses. Determine which ones are necessary and which you can put on hold for a while.
Necessary expenses are your monthly bills such as utilities, mortgage, debt payments, groceries, and transportation needs. Expenses that you can do without are those allotted for discretionary spending such as dining out, going to the movies, and shopping. As you create an emergency fund, make sure that you have enough to cover at least your necessary expenses.
Paying off debt is just as important as saving for the rainy days, and it can be challenging to strike a balance between both.
Experts say that if you have high-interest debts, you should prioritize paying them off first and keep at least $1,000 in your emergency fund. With this amount, you can cover most medical emergencies and other small financial hiccups you may face along the way.
Letting high-interest debt sit around for long may mean more dollars you need to pay in interest. So the best thing is to get rid of them as soon as possible so you could focus more on boosting your savings and building your emergency fund.
Meanwhile, if you only have low-interest debt, it would be safe to have an amount that covers at least two-month’s worth of your living expenses tucked away in your emergency fund. If you have children dependent on you, you can increase its size just to be on the safe side.
Other income sources
Do you have other income sources aside from your job such as allowances, investment income, and earnings from a side job? If so, you need to factor them in as well. Determine how much you can expect from them and how liquid they are.
Even if you have other monetary sources available to you, keep in mind to use them only as supplemental sources in case your emergency fund falls short of your needs. Remember that the goal is to keep your finances intact even during a financial setback, so utilize these sources only if necessary.
Having an emergency fund doesn’t prevent life’s challenges from coming your way, but what is does is keep you financially well during the rainy days. If you don’t have one, start building your emergency fund now with these important factors in mind.