Budget Basics 101: Why do you need an emergency fund?

Over the next few weeks or months we’re going to break down the process of budgeting into a series of questions many newcomers to the process tend to ask at one time or another. They aren’t silly questions because, as we all know, there are know silly questions. In fact, many of the queries we’ll answer in Budget Basics 101 are very common concerns to those with financial strife. Without solid answers and the reasons for them, budget newbies may set up an improper budget or give up altogether.

We hope the information give provides a sense of security to those setting up a budget for the first time. And for those who have been diligently working on their budget, the data should be a reinforcement of information they already knew. So, without further ado, let’s discuss the first question:

Why do you need an emergency fund? And how much do you need?

No matter how secure one’s monetary situation is at any one moment, there may come a time where the financial floor drops from under them. It could be the loss of a job, a high-reward law suit, a vehicle accident, or a injury which requires extensive hospitalization. Regardless of the reason, the consequence could mean a large financial burden.

Hence, the reason for an emergency fund. What it’s used for is, well, emergencies. It isn’t used for regular bill paying, groceries, or the Caribbean vacation someone absolutely needs to take. In fact, the money within an emergency fund should be consider toxic until it is truly needed. This is why a budget should be in place — to have the money for the extras. The emergency fund can be storied in a mason jar in a bedroom closet or a separate bank account. Either way, it can’t be touched until a dire situation arises which requires its use.

In most circumstances, the next question people ask about the emergency fund is how much money it should keep. This is a two-part answer for those who are creating a budget to pay off debt. At the start of the process the amount to keep in the fund is between one and two thousand dollars depending on one’s current financial situation. The first thousand is just fine to cover repairs or unforseen medical bills. The second thousand is a cushion if you know emergency expenses may be higher at some point.

Once debt is paid off, the emergency fund needs to be populated with three to six months of household expenses. This includes rent or mortgage, utilities, groceries, transportation funds such as fuel and tolls, and clothing. In other words, the basics one would need to survive for an extended period of time should a layoff or extended injury occur. The biggest reason for this amount of money in the fund — to provide a comfort zone while the financial situation stabilizes.

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