Having an emergency fund is a little money saving trick that is often overlooked. But, I want to drive home some things about them: how to start one, why you need it, and how saving money will actually save you more money.
Starting an Emergency Fund
As we all know (or as you are learning right now), every single person needs to have an emergency fund. Maybe it’s somewhere around a thousand dollars to start, and eventually it grows into three to six months’ worth of living expenses. This money is kept in a very liquid (accessible) account like a savings account or a money market account. Your options for this account are numerous. Remember, don’t go hunting for some great interest rate – you won’t find it. You want something that is easy to set up and easy to withdraw money from in case of an emergency.
Here at YNAB, we’re firm believers in saving for non-monthly expenses (which we call TRUE expenses). If you’re already a savvy YNABer, I know what you’re thinking:
If I save for True Expenses, I don’t need an emergency fund!
But actually you do, because none of us can predict the future with 100% accuracy. Some things will happen that you just could not see coming, and that’s what an Emergency Fund is for! Simply put: it’s one of your true expenses.
To start an emergency fund, give yourself permission that it might take some time. You can set up an automatic deposit into your savings account of $100 a month. In ten months, you’ll have your emergency fund.
Before you start an emergency fund, you might’ve heard that you needed one, but you aren’t quite sure if this falls in the “nice to have” or “need to have” category. We’ll just tell you: it’s a “need to have,” and here’s why:
An Emergency Fund Protects You From Debt
A lot of people say they have a credit card because they might need one in the event of an emergency. I think this is ludicrous, but that’s a different subject all together. Let’s suppose that an emergency comes up and you need to fork over $1,000. With an emergency fund, you simply pay it all up front and begin replenishing your account.
If you didn’t have this money set aside, where would you turn? To your “emergency” credit card, so, you charge the $1,000.
If you had an emergency fund, you would be right up to par again by socking away $100 a month for another 10 months. But if you charged the $1,000 and paid $100 a month to pay it off? It would have taken you almost another full month. It cost you about $86 extra dollars (assuming an average 18.61% APR) just to charge it on your card. That may seem small to you, but couple that with other credit card balances and you have a pretty formidable giant you’re playing footsie with.
So when saving money, you save on interest because you have the money when an emergency strikes. The emergency fund replaces the emergency card.
An Emergency Fund Lets You Take More Risks
I have a high deductible on my auto insurance, because I know I can cover that deductible with my emergency fund. If I switched to a lower (or no) deductible (as many people do), it would cost me another $630 per year, and that’s just on one vehicle!
Most people are scared when it comes to choosing a high deductible. Why? Because they don’t have an emergency fund. When you have your emergency fund in place, you’re allowed to live with a bit more “risk” if it’s even correct to call it that. In reality, you’re living with less risk – further from the edge, and you can save more each month because of your savings.
Anyone who chooses to lower their deductible so they don’t have to pay out more money in the event of an emergency, but doesn’t have an emergency fund, is playing with fire – now there’s risk. That’s a game I just don’t like to play.
So What Counts as an Emergency?
So how do you tell if an expense is really an emergency?
- You really could not have predicted it.
- It feels like an emergency.
Yep, we get to use our judgment on this one. For one of our teachers, Erin, she describes the day when water stopped leaving her house and was getting backed up, or the time when she flew her nephew home for Thanksgiving three days before because his girlfriend broke up with him and she didn’t want him alone on the holiday. Those were two expenses that she pulled from her emergency fund. There’s no category for that, you know?
Save Money by Saving Money
You might think that having your money stashed in a savings account earning little to no interest is costing you a lot in opportunity, but I tend to see it a different way. When you have that money there to fall back on, you save on interest costs associated with having to borrow money to get out of a jam, you can save on insurance premiums with higher deductibles because you have money sitting there to cover that high deductible if you need it. An emergency fund is really the only way to go. Start saving money by saving some money.
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