How To

Create a Personal Budget: Creating an Emergency Fund

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In almost every piece of general personal finance advice, you’ll skate across a recommendation for an emergency fund. Whether it’s for the “oh no, I broke my leg” moment; or the “oh no, my engine just blew up” drive; or the “I just got fired” shock; it’s critical to have that rainy day money stored away for just such an occasion. Even if you create a personal budget, you still need to have an emergency fund.

There are a few components to just such an emergency fund, which we’re about to go over. You should be able to access the fund easily, for example: it shouldn’t take over a week to access. You should use the fund only for an emergency; and we don’t mean for emergency Vegas bets, either. Although it’s a relatively simple concept, an emergency fund is a cornerstone component for every financially responsible young professional.

Just How Much Should I Hoard Away?

The amount of money you should have in your emergency fund varies. Experts often recommend to keep it at a minimum savings of three to six months worth of basic living expenses. On the other hand, many experts also believe that a fund of that size may be hard to accumulate, so they also suggest smaller fixed amounts between the ranges of $1,000 to $3,000.

In the end, how much you really need depends on how you create a personal budget. The life and expenses of a young professional varies significantly, after all. Some of us may already have a family, while many of us are content being a single. Some of us may have a mortgage, while others enjoy living in an apartment.

The factors to consider include:

  • The more people you need to support (besides yourself), the more unexpected expenses may occur — thus, the larger your emergency fund should be.
  • How easy is it for you to find a new job if you suddenly lose your old one? Compare the demand for a professional Technology Blogger (heh) to that of a nurse. If you’re a nurse and suddenly get laid off, you may have little trouble finding a new job within a reasonable time frame.
  • As it is with finding a new job, you should also consider your current job security. How stable is your industry? Is your company on the verge of bankruptcy?

To make things easier, besides the factors mentioned above, try a brainstorming session of what may count as emergency to you. List how much each situation may potentially cost. After you’ve given some thought to these scenarios, you should have a better understanding of how much you may need in case of that rainy day.

Steps to Building an Emergency Fund

  1. Set an amount that you’re comfortable with. If you know for sure you can’t accumulate three to six month worth of basic living expenses (that is, food, lodging, transportation, etc.), try the smaller ranges of $1,000 to $3,000.
  2. Start saving right away. Any amount will do. After you’ve met your basic living expenses, you should put away any extra money towards an emergency fund.
  3. Having difficulty finding spare change to save for an emergency fund? Try cutting down on your expenses temporarily. Skipping that weekend where you treat your buddies out, or withholding yourself from premium cable for a few months, can quickly add up to sizable amounts. You can always tack these expenses back on after you’ve built your emergency fund. Who knows? You may also find out that you’re perfectly okay without these luxuries. This is where creating a personal budget will really help you.
  4. Paid off a recent bill, like an auto loan or credit card statement? Keep paying the same amount — this time, to yourself.
  5. Got a nice fat tax return? No, it’s not vacation time. If you don’t have an emergency fund, this is a great boost toward building one.
  6. Keep your funds in a liquid account, so it’s easy to convert into cash. A checking account, saving accounts, money market accounts, and even a Certificate of Deposits can work (although there may be penalties to early withdrawals from the latter). For those comfortable with Internet banking, try the many high-yield online savings accounts such as ING Direct or HSBC Direct. Wherever you choose, avoid an account with fees that may actually diminish your emergency fund in the long term.
  7. Don’t keep for fund where you can spend it easily. This is not an issue if you’re disciplined, but for some, keeping it liquid also means that it can be spent more easily. If you’re unsure of your discipline in leaving the emergency fund alone, open a checking/savings at a separate bank. This gives yourself some barriers to think twice before you cash the fund.
  8. Once you’ve met your emergency fund goal, move on to other financial goals. Now you can worry about other goodies such as saving and investing for retirement, and saving for your children’s’ education.
  9. Reexamine your emergency fund’s size periodically — especially during life-changing events. Finally got hitched? Suddenly have a kid? Landed a hot new job? Reexamine your fund’s size to see how well it correlates to your current situation in life. Perhaps it may be time to put a little bit more in.

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Break (Only) in Case of Emergency

Remember that an emergency fund is only for an emergency, and not to be taken lightly. These chunks of cash are a necessary part of any sound budget. Go without one, and you’ll risk falling into unmanageable debt all the more readily. The bottom line is, don’t let yourself pay those sudden bills or loans on plastic alone! You should always have a bit stashed away to back yourself up.

This post was written by Cap of StopBuyingCrap.com.