An emergency fund is a saving net when you go through difficult moments, such as losing your job or restoring your house. Furthermore, having some extra cash on hand can help you handle unexpected expenses caused by medical issues, car damage or any other emergency situation.
Plus, an emergency fund can help you avoid debts in moments when you’re in desperate need of cash. For example, you can even enjoy the vacation you’ve been planning for years without worrying about expenses.
Looking for payday loans in Akron, Ohio to be able to pay your ride back home can be a life-saving solution. On the other end, using a small part of your emergency fund to buy a plane ticket and be back to work on time costs less in the long run.
Not convinced yet? Learn more about emergency funds, to see how they can help you improve your lifestyle and help you achieve financial independence. Here are five common questions about emergency funds and some answers to help you decide:
How Much Do I Need?
It depends on your spending habits. Generally, you should have the equivalent of three to six months of your income – which is the average time you need to find employment, in the case you’re losing your current job.
The amount depends on your status as well. If you have a large family, you need more money on your savings account, as your monthly expenses are bigger. An average American family spends around $550 a month on food alone.
Cutting some expenses you can make it to the end of the month with $4,000. Assuming your partner has a job, you still need to contribute to current expenses with $2,000 – $3,000 – in this case, you need an emergency fund larger than $6,000 or $9,000.
But, in the end, it all depends on your lifestyle. There are people with $5,000 in their emergency fund who don’t need more to buy food and pay their bills.
Is a Credit Line an Emergency Fund?
An unsecured line of credit sounds like a cheap alternative to the emergency fund when you want to direct as much as you can of your money to pay off debts. And it may be a nice solution to an unexpected expense. Until it isn’t.
A line of credit – even at 3% of interest (which almost never happens) – is still a debt you’ll have to pay off. When you’re already working so hard on paying student loans or a mortgage, the extra debt can become an additional stress to deal with.
You can try to have them both – a smaller emergency fund (enough to cover one-month expenses) and an unsecured line of credit you can count on. This way, you’ll be less worried about unexpected expenses and you’ll still win some time, if unable to work for a while.
Some people prefer to use all money to pay their debts or to invest in the stock market rather than building an emergency fund. And, most probably, they could make it through hard times using a credit line.
Yet, before going for this alternative, think about how you’re going to pay the extra debt.
Where Should I Keep the Money?
Keeping your money in a checking account or a savings account won’t bring you any profit, as most interest rates can barely keep up with the inflation rate. So, you should be looking for alternatives that allow you to access your money fast and still pay you a fair enough interest.
- Money markets accounts – your money will be invested in government securities, certificates of deposit, or commercial paper. Generally, you have restrictions when it comes to withdrawing your money – limited amounts in a given period of time. Depending on the financial institution, initial deposits can start at $100
- High-yield savings accounts – they pay slightly higher interests than traditional accounts. (around 1.25%-1.30%). Plus, they’re federally insured up to $250,000.
- Short-term certificates of deposit – they pay higher interest, but in most cases, you can’t use the money before the certificate of deposit matures. Otherwise, you have to pay a penalty to cash out.
It’s important to keep your emergency fund separated from your regular account so that you’re not tempted to spend more than you can afford.
Can I Save Money in an Emergency Fund If I’m in Debt?
Yes. In fact, having an emergency fund to rely on can help you avoid extra debt in the long run. Just by putting away 5% of your wage directly into a high-yield savings accounts, you can save yourself money on high interests in the future.
When you start working, paying off existing debt is a priority. But so it should be your retirement plan and an emergency fund. Otherwise, you’ll have to rely on credit cards to pay your bills or cover emergency expenses. And interest rates for a credit card are a lot higher than your mortgage or your student loan.
Calculate how much you need to fix a damaged tooth, for example. Add an interest of 15% (as you’ve paid with your credit card) and include the debt into your monthly expenses. Is having an emergency fund making more sense now?
I Reached My Goal. What’s Next?
Congratulations on building your safety net! Now it’s time to think about retirement and paying off your debts.
Make retirement you priority. Supplying your 401(k) plan can bring you free money from matching contributions from your employer. Plus, every dollar you add places you closer to your retirement.
At the same time, try to get rid of credit card debt, which is by far your highest expense. Then, you can try to pay your mortgage or student loans faster – take time to study the market and see whether this is a smart move or not. In some cases, paying off debt ahead of time can increase your expenses.
Ideally, you can still use 30% of your income for your personal needs, once you’re done acting like a responsible adult. So, invest in yourself, plan a vacation, or learn to make more money with stocks and bonds. After all, if something bad is going to happen, you have an emergency fund to rely on.