Establishing an emergency fund is essential for creating a strong foundation for your finances. Without some savings, even the smallest emergency will leave you in dire straits.
You will want to have about 1 month of living expenses in this fund before you do almost anything else financially. If you are just starting out, it is impossible to be prepared for everything, so you may have to rely on help from your parents or take credit card loans if something really big comes up. As you continue to save and work on your finances, you will become more and more able to absorb small emergencies without having to worry about where the money is going to come from.
Gradually you will build you emergency fund up to either 6 months of expenses, or however large you feel comfortable with. The goal is that should you become unexpectedly unemployed or encounter an emergency expense you will not have to sweat it. One good rule of thumb is to save enough to carry you through however long you believe you may reasonably be unemployed if you lose your job. On average this may be about 6 to 8 months, but it may be longer or shorter depending on your individual situation.
Your emergency funds must be accessible within a few days, but need not be instantly available. Most of the time, you will have at least a couple of days to come up with the money. For immediate payment, you can use credit cards or perhaps take a short term loan from a friend. It is often be better if your emergency savings are not immediately available they are not so you won’t be tempted to spend these funds. This also typically allows you to earn a better interest rate.
Emergency funds should be held in a separate savings account and not intermingled with funds for other purposes. You don’t want to spend these funds on anything that is not a true emergency, so a separate account will keep your accounting 100% accurate.
An online bank will work well for this purpose because they pay higher interest rates, and the instant availability of a bank branch is unnecessary for these funds. If you need the funds, you simply send an electronic funds transfer to your checking account or to pay off your credit card.
By establishing an emergency fund, you stabilize your finances and minimize the financial pain caused by life’s unexpected events. If you take this important financial step, you will sleep better at night, and be better able to cope with emergencies if and when they occur.