Once upon a time, I heard of this crazy finance guy, Dave Ramsey, and I read all of his books. I realized some of the things he teaches are actually genius! And we quickly jumped on the Dave Ramsey bandwagon to dump our debt and change our family’s financial tree.
If you’ve been following along at Little Light on a Hill, you read how we used Dave’s Debt Snowball method to pay off over $80,000 of debt. We are now debt free except for our mortgage, and it feels. so. good! We are now working on building up our emergency fund. So I thought it was time to write a little bit about what that means and what it might look like for you.
What is an Emergency Fund?
An emergency fund is a set amount of money that is put into a savings account. It should only be accessed in a true emergency.
I think it’s important for us to realize what an emergency is NOT. An emergency fund is not to be used for expected expenses. For example, Christmas is not an emergency. The date stays the same every year; it is expected. You can start a Christmas savings fund to offset the cost. But Christmas expenses should not come out of your emergency fund. The same is true for birthdays, other holidays like Mother’s Day and Father’s Day, and things like routine car maintenance and oil changes.
New clothes? Not an emergency. Your summer vacation? Not an emergency. That purse you’ve had your eye on that is finally on sale? A new TV? Shoes? No, no, and no.
An emergency fund should be saved only for unexpected life emergencies. When your car breaks down, your tires need to be replaced, your refrigerator or A/C unit blows and stops working. These are all examples of a true emergency. Unexpected medical bills or a job loss also count as true emergencies.
You will work really hard to build this emergency fund up, so honor your hard work and only use your emergency fund for a TRUE emergency.
Why Do You Need an Emergency Fund?
If you lost your job tomorrow, how many bills would you be able to pay? If you or a loved one were in an accident, how much would you have saved for medical expenses? Most Americans would not even be able to cover one month’s worth of bills if they suddenly lost their income. I know I used to be in this category! Are you?
You need an emergency fund to avoid a financial disaster if one of these things happened to you. An emergency fund will give you the peace of mind to know that your family will still be taken care of in case the worst happens.
Do You Need a 3 Month or a 6 Month Fund?
Many financial gurus have their own thought process on this. An amount that works for one family might not work for another. I’ll be the first to say you need to find what works for YOU.
So now that we understand no emergency fund will be the same, how do we know how much we need?
When my husband and I were first married, we had a small amount in savings. About one month’s worth of expenses. When I finally graduated college and got my big girl job, we upped that number to cover three months of expenses. I had a very secure job as a teacher, and my husband had been at his job for a while so he felt confident in his job security as well.
For this reason, we knew three months was enough for us. If he lost his job, I would still have mine. And vice versa. So technically, our emergency fund would have covered up to six months of his income alone, or my income alone. The odds of both of us losing our jobs at the same time were slim to none. But in the off chance that this did happen, we would have had three months of expenses covered.
Now that I have walked away from a career I loved, and am staying home with my girls, we are a one income family. Many of you read our story of how we paid off all of our debt except the mortgage. Being debt-free provided the opportunity for me to stay home with my family, but our income plummeted.
Cutting our income in half seemed crazy to so many of our friends and family. And to us at times!
But I wouldn’t trade the simple life we live for anything.
Since we are now a one income family, if my husband loses his job or gets sick or in an accident and is unable to work, we feel like a three month emergency fund is not enough and we are saving for a six month fund. It might take a while, but that’s the goal.
When thinking about your own emergency fund, think about your family’s specific needs. A married couple with two very secure jobs might only want to save a three month fund. If one person loses their job, the other person would need to pay their half of the bills while their emergency fund could cover the other half. But if you are already a one income family, or one of you is in an unstable job, or you have a child with special needs and expenses, or your finance needs ebb and flow month to month, you might feel more comfortable with a six month fund.
Whatever your situation, figure out what you are most comfortable with: 3 months or 6 months.
How Much Do You Really Need?
When you know how many months of bills you want to be able to save, you need to figure out how much you need each month. This is not 3 or 6 months worth of your income. It is 3 or 6 months of expenses.
Take a look at your monthly budget. You will need to save for your rent/mortgage, utilities, gas, groceries, medical needs, etc. Ignore anything extra that is not a need. Things like cable, magazine subscriptions, and eating out. Anything that is not necessary for survival will need to be cut if you find yourself living from your emergency fund.
Once you add up the expenses for all of your needs, multiply that number by 3 (for a 3-month fund) or 6 (for a 6-month fund).
Once you decide it is time for an emergency fund, start by saving just $500, and work your way up to $1,000. Then save enough for one month’s worth of bills, then two, then three and six. Just start! Every month will get you closer and closer to your goals. You will be so glad you started when you did.
Interested in learning more about how we manage our finances?