When you are driving a vehicle on a long journey it makes a lot of sense to keep changing the engine oil every 3,000 miles. Similarly, it is prudent to keep an eye on your child’s education, understand their requirements and prepare for the long term needs. Looking at this, it makes a lot of sense to build an emergency corpus, which can help you come out of the emergency requirements successfully. What is really important is to analyze your future requirements and plan your finances accordingly. When you are saving for the emergency, you need to see that the places where you are parking your money offer you a substantial return which makes these investments viable.
What is the right amount which can help you meet your future expenses cannot be ascertained in simple ways. In fact, one has to take a complete stock of their budget, monthly expenses, income, family, lifestyle expenses and also the future expenses like the educational cost of the children, buying of home and vehicles and similar things. Other than those looking at the current state of the economy where recession has taken jobs of many and destroyed their finances, how soon will they regain their lost status is still under consideration. For some who can get back to jobs early may be within 3 months, an emergency fund for a similar amount can be sufficient. There are others who would require more than 1 year getting back to a job and hence for them an emergency fund which can help them meet their expenses for a minimum of 1year will be required.
Thus, what is the right amount for an emergency fund cannot be predicted in advance. Life is full of uncertainties and the more you save, the better it will be for your life.
Do the Math
When we talk of the emergency funds, it takes a lot to understand the amount of money we are talking about. Industry experts and the survey reports confirm that an average American earns anywhere up to $42,693 annually, while the personal savings amount to anywhere around 4.9%. Based on the assumption that the person comes in the tax bracket of 20%, an emergency fund which could suffice eight months of living expenses would require one to save around $22,000.Even if one considers three months being their emergency period, one would require $10,000. When we look at these figures alone, they might look to be high, but considering the fact that in the US, an average American holds credit card balances to the amount of $5200 , the emergency fund may actually prove to be insufficient if the emergency situation strikes.
With inflation rising everyday if one would save towards the emergency funds without considering the returns on them, they are set to lose the money because the money devaluates with time. So, if $100 would buy you an item today, you might require $110 to buy the same item after a year. This means that if you are unable save in places and financial instruments which can offer you returns which are sufficient to meet inflation, your emergency funds will simply degenerate with time. The returns should be such that they can beat inflation and offer you some extra percentage on top of it.
Clear Debt First
Emergency funds are for everyone irrespective of their financial status. However, those who are having multiple debts like credit card debts, student loans, auto loans and mortgage loans, should work towards creating an emergency fund with a single focus of repaying these debts fast. If you are able to control your expenses, there are better chances that you will be able to save more towards your emergency fund. However, when we look at life, it is not that simple. There are several situations where we might have to spend money, which we might have never thought of. These situations can be anything like accidents where your vehicle requires immediate repair, medical emergencies which require immediate funds to cater to them. No matter how diligent you into managing your finances, such situations have all the potential to eat into your savings.
If you take steps and clear your debts well in time, you will always find yourself in a better position to deal with the emergency situations. If you have a debt repayment amounting to 15% of your monthly income, clearing your debts would release the 15% money which can be put towards the emergency fund. Other than this, one would be saved from the penalties and extra fees which they would be required to pay if they miss on the timely payments.
Even if you invest your money you set aside towards the emergency funds into the financial instruments like the CDs or the Federal bonds, you will get returns which are sufficient to meet inflation in the normal situations.