Why & How to Create an Emergency Fund

An emergency fund is an essential part of every family’s financial plan, yet so many people don’t seem to have one set up.

Wouldn’t it be nice if you no longer had to worry about what would happen if a financial emergency came up? That’s exactly the kind of security you can get with an emergency fund and exactly why you should have one in place.

What is it?
An emergency fund is pretty much what the name implies – a pre-determined amount of money set aside for you to use in case of an emergency. A real emergency, such as your car breaking down, job loss or a death in the family. Not a pretend emergency like a pair of pants for a new job or a dinner out because you’re too tired to cook.

How much should you save?
The amount of money in your emergency fund will vary from person to person and family to family. If you have quite a bit of debt to pay off, I suggest an emergency fund of $1,000 to get you started. Once your debt is paid off, it is recommended that you put aside 3-6 months worth of basic living expenses.

Basic living expenses means only the necessities. Housing, food, transportation, etc. Don’t include things such as new clothes and entertainment. Figure out what that amount is every month and try to save at least 3 months worth to put into your emergency fund.

Where should you keep it?
Don’t keep your emergency fund in a regular chequing account at the bank. Stick it into a high-interest bank account so that you can earn a bit of interest on it while it sits there (since you won’t need to touch it often). ING Direct is a great bank for this, since it can all be done online and is free.

Whatever bank you choose to use, make sure that the money is fairly easy to access if you need it. You also don’t want to put it into any account that will penalize you when you make a withdrawal.

Start saving.
Once you have determined how much you would like save and where you are going to save it, you need to move on to the most important step of all – actually saving some cash for emergencies!

Since I believe that an emergency fund is a crucial step in building a solid financial future, I always suggest that people make that their main goal when planning where their money should be going. Squirrel away as much money into your emergency fund as possible, until it is fully funded. Then you can start focusing on other goals, such as debt repayment and planned savings (down payment on a home, vacation, etc.).

Don’t touch it.
Once you have created your emergency fund and saved an amount of money that you are comfortable with, you need to leave it alone. It sounds easy enough, but this is one mistake I find many people making – using money in their emergency fund on things that are not true emergencies.

Don’t do it!

This is why I like to keep our emergency fund in a different bank (ING Direct) than the one we use for regular banking. If I can’t see that the money is there, it is much less likely that I will spend it.

The only time you want to reach into your emergency fund is when you are faced with a real emergency. Otherwise, don’t touch it.

I hope that this post has encouraged you to create an emergency fund (if you don’t have one already). I really do believe that they are a must-have financial tool for everyone.

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