Having an emergency fund is a crucial part of your overall financial health.
Let’s start with the basics, what is an emergency fund? An emergency fund is a lump sum of highly liquid capital available for immediate use just in case something happens. In other words, it’s money that’s set aside to cover unexpected events that may come up in life such as medical bills or losing your job.
What is highly liquid capital? A liquid asset is something that can be readily converted to cash. Most often it is cash that you set aside in a checking or savings account, but can also be money held in money market funds (earning slightly more interest than a checking or savings account). If you already have a checking or savings account, then you technically already have an emergency fund!! You just need to make sure there’s enough set aside ;).
Why is liquidity important? Emergency funds are typically necessary when someone needs to dip into their savings to cover a large cost and therefore the money needs to be available immediately. Cash and money market funds are the only products that are risk free and highly liquid.
How much should I save in my emergency fund? Usually between 3-6 months of your expenses. The 3 month emergency fund usually applies to couples with two or more sources of income while the six months applies to one source of income. Check out our budget tracker to figure out how much you need to save for your 3-6 month emergency fund.
What am I risking by not having an emergency fund? A worst case scenario would be that an unexpected expense comes up (i.e. car maintenance, doctors bills, or you lose your job) and you don’t have enough savings to cover the expenses. You would therefore need to borrow money which may come with high interest rates.
Financial planning is all about risk mitigation. The less risk the better. Having an emergency fund is an important step in living a financially healthy life and can help you to feel more comfortable with your finances.
Coming up next in this series, how often you should be checking your accounts. If you want to revisit the other posts in our series on “Being Financially Healthy”, check them out here.