You know you should have an emergency fund, but that’s easier said than done.
How much money are you supposed to save? What exactly is this fund used for? And how do you balance setting aside money with those student loan bills (sometimes big ones) that need to be paid now?
Emergency funds don’t have to be confusing, and they don’t have to derail you from your other financial priorities. Here’s what you need to know to start your own.
What’s an Emergency Fund, and Why Do I Need One?
First, let’s start with what an emergency fund is not.
An emergency fund is not something you tap into when you need to pay occasional bills like vacations, holidays, your annual car registration or your trip to the dentist every six months. These things may not be regular expenses, but they’re still expenses you can anticipate, and you should be accounting for these in your monthly budget.
If you know your annual trip to Las Vegas will cost $X, divide that number by 12 to get the amount you need to set aside monthly for this goal. Put that into an “irregular expenses” savings account.
Your emergency fund is for true emergencies—unforeseen scenarios you couldn’t anticipate, such as a sudden job loss or huge health crisis.
An emergency fund can be a lifesaver in these situations. If you get sick, get laid off, or face a sudden car or home repair bill, this safety net will become your saving grace.
Murphy’s Law isn’t just a clever cliché; life has a way of throwing unexpected costs at us from time to time. If your car’s engine dies two weeks after you get laid off, you’ll thank your lucky stars that you saved up for this type of calamity.
In short, an emergency fund cannot only save your budget, it can give you some peace of mind (which is every bit as valuable).
How Much Should I Save?
Financial gurus recommend different amounts.
TV personality Suze Orman recommends saving up enough money to cover 8 months‘ worth of expenses.
Many financial experts shoot somewhere in the middle, saying you should err as close to the 6-month side of that spectrum as possible. (When it comes to establishing financial security, more money is always better than less.)
Whatever number you choose to strive for, it’s worth noting that experts disagree over whether your calculations should cover all of your expenses during those months or just your “necessary” expenses.
Are you talking 3-6 months of dining at posh restaurants and going to the movies, or 3-6 months of strictly groceries, utilities, and other non-luxury items? Is cable TV included? What about your gym membership?
The answers to these questions are up to you to decide. If the worst happens and you lose your job, you may choose to cut back drastically on non-essentials to make your money stretch as long as possible.
Or you may save up a little more now to give yourself more breathing room and allow yourself to indulge (in moderation) during times of crisis. Decide on your personal must-haves and plan accordingly.
Emergency Fund vs. Student Loans: How Do You Prioritize?
There’s one question we haven’t yet answered: How do you juggle building an emergency fund with paying down your student loans?
First and foremost, you must make the minimum payment on your loans. Never skip payments (but that should go without saying). But how should you balance building an emergency fund with making additional payments to accelerate your loan payoff?
Going back to the gurus, Dave Ramsey recommends saving $1,000 in an emergency fund first, then focusing on repaying your debt, and then building your emergency fund more to cover 3-6 months of expenses. It’s a back-and-forth strategy that balances both priorities against each other.
However, note that Dave heavily prioritizes paying off debt compared to other financial goals. With this in mind, you’ll have to decide for yourself if that’s what makes sense for you.
Others argue you should save a bigger emergency fund right off the bat—maybe 2 months’ worth of expenses to start — then make additional payments on your loans. Once your loans are repaid, build your emergency fund to the six-month mark.
The interest rate on your loans will play a role your personal decision. Paying down subsidized Stafford Loans is different than repaying private loans with 10% APR. If you’re paying a large amount in interest each month, you may choose to start with a smaller emergency fund so that you can focus on getting rid of high-interest debt.
Whatever you decide, one thing is clear: an emergency fund should definitely be part of your short-term and long-term financial plan.
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