Why you need a Short and Long Term Emergency Fund
It’s important to have an emergency fund to cover unexpected expenses. Job loss, medical emergencies, unexpected home or auto repairs, and unplanned travel needs are just a few types of emergencies that can arise. Having a fully funded emergency fund can help you avoid borrowing money or accumulating credit card debt to cover these types of costs.
In this blog, we’ll cover short- and long-term emergency funds, things to consider when starting an emergency fund, and how to recover if you need to use your emergency fund.
When starting an emergency fund, it’s important to consider a few things like liquidity. Liquidity means keeping your funds in cash so you can access them as quickly as possible. For example, if your money is tied up in stocks, bonds, etc. it may take some time to liquidate them. Although keeping your funds in cash may mean lower yields, it’s important to be able to access your money quickly.
It’s also important to ensure that your money is accessible. For example, certain savings accounts like certificates of deposit (CDs) have required terms. If you take your money out before the term is up, there could be a penalty. If you are worried about having to pay a penalty in order to access your money, you may be less likely to use the money during an emergency, and more likely to pay for the emergency with a credit card, which defeats the purpose of an emergency fund.
A popular option for managing one’s emergency fund is a high-rate savings account. You will earn a higher interest rate than in a typical savings account, but still have access to your money whenever you need it. Make sure to double check the fine print, but typically there are little to no penalties for taking money out of a high-rate savings account.
Once you decide on the best place to keep your emergency fund, it is time to start a short-term emergency fund and a long-term emergency fund. Short term funds are typically between $1,500 and $4,000 and are meant to cover relatively small expenses like a new set of tires, a broken appliance, etc. Long term funds are typically six to nine months of living expenses (not income, just living expenses). The amount you save depends on many factors like whether you rent or own your home, whether your income is consistent each month, how many dependents you have, and more.
If that feels like a lot of money, don’t get overwhelmed. A small emergency fund is better than no emergency fund, and you can add to it over time by automating part of your paycheck to deposit directly into your savings account. If you have to use some of the money for an emergency before it is fully funded, don’t worry, that’s what it’s there for. Simply replenish the funds when you can and continue to grow your savings.
To get your emergency fund started make a budget and determine where you can start saving money. You should also determine how much money you want to save in both your short-term and long-term emergency funds. Set a goal to save a certain amount per month. If you automate your savings, it can be easy to make sure the money goes into savings before you have a chance to spend it. As you get more comfortable saving, gradually increase your savings goal.
Eventually, once you get your emergency funds set up and begin funding them, you can also start to budget for unexpected expenses. An example of an unexpected expense is if your dishwasher is getting older and is starting to go, you can anticipate that you may need to replace it within the next 6-12 months. You can start saving for items like this as part of your budget so that when you do need to replace it, it’s no longer an emergency, and you have the money ready to go.
Setting up these savings funds will help you get in the practice of saving, and it will help you when you encounter an emergency or set back in life. It’s important to have a cushion to protect yourself, and starting a short-term and long-term emergency fund before you need one will certainly help. Your future self will thank you!