The importance of an emergency fund

Let’s face it. Life happens!

We’ve all been there. Your air conditioner breaks, your car gets hit by and uninsured driver or perhaps a medical expense out of pocket bill is over $1,000.

Without an emergency fund, almost everyone would panic and just reach for a credit card. But if we’re trying to improve saving money and plan for our financial future, adding extra debt is not how we want to go about doing that.

Thus an emergency fund (or lack thereof) can literally make or break your household budget. This is a simple savings account in your bank. It’s not an investment and you need to have easy access when you need it. It should be separated from your regular savings account and only used for true emergencies.

Ideally, you should have not 1 or 2, but 5 bank accounts.[2] Having a separate account for each purpose will help keep you on track with saving money in each individual category.

How much should you put in an emergency fund?

If you don’t have an emergency fund, start one today. Make your initial goal to be $1,000. As you get out of debt and get your financial ducks in a row, build that up to 3-6 months of your monthly expenses.

Note I said expenses and not income. I would also suggest that in a real financial emergency (job loss for example), radically cut expenses down to the essentials.

Why the 3-6 month range? In a word, it depends on job security. In a stable 2 income household where both bread-winners have been employed for 2 or more years, 3 months is fine. If you have 1 income or unstable or inconsistent income, go towards 6 months.

For most 2 person households with 2 or more kids, we’re talking a minimum of $8-10,000. Depending on your income and expenses though, it could be twice that.

Can’t quite figure out how to even save $1,000? Check out these Eight Simple Ways to Save for an Emergency.

Crucial steps to take for holiday spending

Almost everyone spends some kind of money around the November and December holiday season. Even if you don’t celebrate Christmas, chances are you buy gifts for your boss or do a gift exchange at work or host holiday parties.

Most folks fail to plan throughout the year for this spending. Then they hit November 1st, panic and reach for the credit cards. Thus it’s crucial, if we’re talking about saving money, that we have a plan for holiday spending.

The key to holiday spending success

The key to holiday spending success is to start saving money for the holidays in January. But even if you didn’t start in January, get started now.

Decide (in conjunction with your spouse or partner if you have one) how much you plan to spend. Make sure to include holiday travel and food expenses.

Then assume you’ll want to start spending that beginning in November. Divide that total by the number of months you have to save (11 if you’re starting in January). Transfer that amount of money into a separate savings account each month.

Many banks and credit unions have what’s called a “Christmas Club”. This is a savings account for holiday spending and they typically transfer it back into your checking account November 1st.

As an example, say your family of 4 plans to spend $1,000, divide $1,000 by 11 and we see that you need to transfer $90.90 into your holiday savings account each month starting in January.