An emergency fund is money set aside for the purpose of playing for your bills if you suddenly find yourself without a paycheck or receive an unexpected bill. Instead of going into debt or worse not paying your bills having extra money available keeps your financial health safe.
In the middle of a crisis, it can be difficult to figure out how to find your way out. The key is to start taking action based on your learnings.
The common recommendation is to have enough months of bills saved in an emergency fund to weather a storm. How long will it take you to find a new job if you lose or need to leave your current one? Maybe it’s 3 or 4 months depending on the market conditions.
But what happens if we have a truly unexpected And to be completely honest I started weeks before the world situation changed.
One quick note I should mention. I’m not a financial planning professional. I’m sharing what’s working for me as part of my investing strategy. Always do your own research and consider your own circumstances before making any financial decisions. You could also check with your favorite financial professional to understand what would be best for your situation.
What is a 12 month emergency fund?
A 12 month emergency fund is cash you set aside to cover a year’s worth of expenses in case of life an unexpected turn. There are many reasons you need an emergency fund, but in this case, consider situations where you leave a job for any reason and are not being able to get back to work for an extended amount of time.
Losing your regular paycheck could be the result of losing a job to a layoff in a difficult economic climate or having to deal with a difficult medical emergency.
Ultimately this won’t be a small amount of money. Starting with $1,000 is great for smaller bills but probably won’t cover all of your expenses for a year.
Is a 12 month emergency fund a good idea?
Ultimately you’ll need to decide what makes the most sense for you and your financial wellness. A few questions to ask yourself:
- If you lose your current job how long will it take you to get a new one?
- How stable is your income?
When thinking about a large emergency fund, it’s usually in the context of losing your regular income, and less so an unexpected bill that’s larger than your regular monthly budget.
If you are in a difficult industry where moving between jobs can take a while or maybe you’re a commission-based worker, having a backup plan is a good idea to keep your finances healthy.
But then there’s also the unexpected. Think about what you expected 2020 to look like and then fast forward to March and what you think about the future now.
That’s not to say in the middle of these unusual events in uncertain times building a 12 month emergency fund would be easy, but on the other side of this giving thought to building a larger emergency fund might make sense.
How to decide how much you need to save to cover 12 months of expenses
The amount of money you’ll need in your emergency fund will depend on your total expenses per year. There’s no single answer that fits everyone.
Start by writing down all of your monthly expenses and multiple each by 12 to understand how much spend per year on those.
Add to the list the bills you pay infrequently such as property taxes, insurance premiums, and any yearly subscriptions.
You may also want to include money to cover regular expenses such as food along with a bit of a cushion to help you manage any unexpected expenses with room to breathe.
The final total will give you your 12 month emergency fund goal. And it will likely be a large number. Don’t panic. This may become a longer-term goal for you to achieve. Taking it in pieces so that you can work on both this financial goal along with others including paying down debt.
3 tips for starting a 12 month emergency fund
Once you’re done figuring how much you’ll need to cover 12 months of expenses, stop for a moment and take a breath. Aside from potentially the downpayment for a house, this is likely the largest savings goal you have.
But now how do you get started tackling this?
If you’ve already started an emergency fund then the additional amount you need to save may not feel as overwhelming.
But if you’re starting from 0, you’ll have a fair amount of work to do.
Break down your goal into smaller pieces
Instead of trying to tackle the entire 12 month goal at once, consider starting with a goal of creating a 3 month emergency fund by a certain date. And then move onto a 6 month goal.
Take a look at your budget and figure out how much you can save per paycheck for the next 6 months.
You may need to tighten your budget to find extra money so you can meet your initial goals.
By building your emergency fund in pieces, you can pause in between phases to work on other financial goals such as investing in the stock market.
The argument against larger emergency funds is that you’re missing out on larger earnings that you might have had in the stock market. Long gone are the days of higher interest rates on high yield savings accounts, unfortunately.
And when the stock market is good you can earn a larger income for your money. But when the stock market goes bad, it can go very bad. If you needed that cash in a pinch, you might not have the money you expected if it’s all in the stock market.
Automate your savings
To help yourself stay on track to reach your goal, automate the savings process as much as possible. The less you have to remember to do the better.
Using direct deposit to automatically send the money to your account of your choice, taking a step out of the process.
You’re likely very busy trying to ensure all of your bills are paid on time. Just like you can autopay some bills, consider building your emergency fund as another bill. You’re paying your future first.
Keep your emergency fund in a separate bank
Reduce the temptation of spending your emergency fund on non-emergency fund things but opening an account at a completely different bank than the one you use every day.
Make sure you find one that has a low balance requirement to avoid fees and pays reasonably well in interest. Depending on the economic conditions this may be easier said than done, but high yield savings accounts usually pay better than your local bank around the corner.
Are you considering building a 12 month emergency fund?
Up until recently most people probably would have told you that’s an absurd goal and you’ll have a better return on your money by investing in the stock market.
But at the same time, you need money on hand to pay your bills when things don’t go according to plan. Depending on the market conditions and your personal expectations having a larger emergency fund might give you better peace of mind.
Building a 12 month emergency fund isn’t something you’ll do overnight and maybe it’s a goal you work on in pieces.
What are your thoughts on having a year’s worth of expenses saved in an account?
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