How to Set Up and Use an Emergency Fund

The saying might always be “April showers bring May flowers,” but I like to rewrite it to say “April showers bring May mudslides.” I favor the latter because the reality is that life is not always going to be flowers. Even the happiest, most successful person is going to deal with disaster in their life at some point, and unfortunately, these disasters often take a toll on our finances. If an emergency arises, many times the only option is to pull the money from other equally important areas (like food or gas) or accrue debt by putting the expenses on a credit card. But, there’s a simple step you can take in your disaster preparedness that will make a huge difference. It’s called an emergency fund.

In my opinion (as someone who has dealt with her share of emergencies), this is the single most important thing you can do to protect not only your finances but your relationships, your lifestyle, and your mental well-being.

As a disclaimer: many of the references and ideas I offer here are part of Dave Ramsey’s Total Money Makeover. I’m not paid by Dave Ramsey to share these thoughts (although, if you know him, tell him I’d love to work for him!), but I share them because they have genuinely worked for us.

My husband and I are working through Dave’s Baby Steps, and we’re now on Baby Step 3. It’s amazing! We’ve paid off a substantial amount of debt in just three years, while still surviving three PCSes, multiple car repairs, a couple appliance replacements, and a new baby. I feel certain that this would not have been possible without a good emergency fund!

So, even if you don’t agree with all of Dave Ramsey’s ideas, the emergency fund is a fundamental concept that almost every financial planner agrees with. It is a basic idea, relatively easy to implement, and will make an enormous change in your life.

Now, I know that if you’re living paycheck to paycheck and already stretching every dollar, it’s overwhelming to think of trying to put this extra cash aside, but it’s doable and absolutely worth the effort.

Here are five basic points for setting up a successful emergency fund:

1. Estimating how much to save.

Dave Ramsey has two thoughts on this. First, if you’re still living with debt (credit cards, car payments, student loans, etc.), working on debt repayment should be your biggest financial priority. Otherwise, you’re losing tremendous amounts in interest versus keeping your money for yourself. However, it’s still important that you have a small emergency fund set aside. Dave suggests $1,000, but I think you need to set the amount based on your situation. Chris and I put aside extra because we knew we could have potentially large car repairs coming up (which you should be able to loosely predict based on mileage). So, I’d recommend keeping an emergency fund somewhere in the $1,000-$2,000 range.

But if you are debt free, it’s time to make a major emergency fund! Ideally, you should have three to six months worth of expenses set aside (not sure about your monthly expenses? That’s why you need a budget!). This will protect you in case of job loss, serious injury, or major life crisis and should be something you maintain for the rest of your life.

2. Remember it’s one dollar at a time.

Literally. I know it seems like a lot of money, especially if money is tight already, but every extra dollar you have should go straight to the emergency fund, and you should focus on making extra dollars to speed up your progress. This might mean giving up date nights for a little while, cleaning out closets and hosting a garage sale, stopping your trips to Starbucks, or carpooling to work. Or, get really serious and cut off your cable, cancel any magazine subscriptions, switch to a cheaper cell phone plan, or pick up some extra cash by working a part-time job. Yes, it is really unpleasant to live like this, but it’s also temporary. Once you have met your financial goals, you’ll have the freedom to spend money on these luxuries again, and you can do it with the peace of knowing you’re also protected in case of an emergency.

3. Set up the account.

The point of an emergency fund is that it has to be easily accessible. If your car breaks down, your emergency fund is worthless if you can’t pull out the cash immediately to pay for the repairs. But, you also don’t want to risk getting it mixed in with your monthly grocery budget. The best plan is to set up a separate savings account with your normal bank—you can easily transfer the money you need to your checking account if an emergency should arise.

4. Use it properly. 

Don’t spend it! Knowing what to do with your emergency fund comes down to understanding what an emergency is. Tory Burch releasing her spring product line is not an emergency. An annual vet visit is not an emergency. A PCS is not an emergency. A baby is not an emergency. If you can put an event on your calendar, it’s not an emergency! Instead, an emergency financial situation is something you should save for in order to use at an unexpected time.

An emergency is a true surprise that you must overcome to continue living your life. Your refrigerator breaking is an emergency. Your car breaking down is an emergency. Your dog eating an entire Easter basket’s worth of chocolate eggs is an emergency (ask me how I know…). These are the reasons why you have an emergency fund.

5. Once you tap into it, you’ll start at the beginning. 

So, let’s say that your dog gets into the Easter candy, and you’re hit with a $600 bill from the emergency vet. You take that money out of your $1,000 emergency fund and are able to pay the bill without using a credit card or having to give up eating for the month. But, now you only have $400 left in the emergency fund. Unfortunately, now you need to go back to the beginning and get back up to $1,000 again. Yes, it’s a pain, but look at the positives—your emergency fund did what you needed it to do. It protected you! Don’t lose out on this protection just because it did its job once.

 

Amazingly, once you master the emergency fund and start getting a strong handle on your finances, you’ll find that fewer and fewer things become emergencies. There were several emergencies where my husband and I didn’t even need to use our emergency fund because we had our budget under control and were able to make changes for that particular month to pay for things.

Nothing will prevent financial disasters, but being prepared can make them far less disastrous. Having a good emergency fund in place is like having an umbrella and rain boots in the midst of the April showers. Instead of getting drenched, you’re free to play in the puddles.

Do you have an emergency fund?  How do you prepare for financial emergencies? Share with us!