What do you do when:
- your source of income suddenly stops?
- you’re suddenly ill and insurance can’t cover all the costs?
- you have to travel immediately due to a close relative’s passing away?
- your car breaks down and you realize you have to spend $700 or more on repairs?
Sure you can use credit cards to cover some of these expenses, but how long can you do that for especially if the first situation is also true. This is when the Emergency Reserve comes into play. It sounds basic and like common sense, but this is the most important account for any independent person (and often the most overlooked). In discussing this, we can focus on the What, Why, Who, Where, When and How?
What: What is an Emergency Reserve?
According to the Merriam-Webster Dictionary Online, an emergency is
An unforeseen combination of circumstances or the resulting state that calls for immediate action
Two words stick out clearly here: unforeseen and immediate. Consequently,
An emergency reserve is money kept aside for unforeseen situations that call for immediate attention and action
This means that this money should only be used for things that are unplanned. Consequently, emergency reserve should be separate from your savings. Usually when we save, we are saving for a goal e.g. a vacation, new gadget, textbooks, accessories etc. As such, while savings is usually money for planned activities, an emergency reserve is money for unplanned activities. In a way, you can call your Emergency Reserve your financial Red Cross because it arrives on the scene when emergency rears its head.
Why: Why should I care about an Emergency Reserve?
As mentioned above, this money is for unforeseen circumstances which can (and does) happen to anyone. Thus the prime reason for having this reserve is simply: peace of mind. Rather than worry about money in a time of crisis, you know there is money somewhere and that helps to focus on the crisis itself. Besides, if you already insure your car and health, shouldn’t you also be insuring your finances as most emergencies hit the pockets first?
Who: Who should have an Emergency Reserve?
An emergency reserve is necessary for anyone who is (or wants to be) dependent on themselves for financial resources. Therefore, this person has some sort of regular income which pays their bills and they are not necessarily dependent on their parents or family members. This reserve is also important for those who have dependents.
When: When should I start an Emergency Reserve?
As soon as possible! Right after reading this article!! I’m kidding. Well kinda. In all seriousness, you never know when you will need this, so it’s best to start as soon as you can.
Where: Where should I keep my Emergency Reserve?
Since this money is required for immediate action, it should be kept in a savings account that is linked to a checking account. This way, the money can be easily transferred when it is needed. I would stress here that it shouldn’t be in a checking account simply because just as much as this money should be accessible, it should also be untouched. With an emergency fund tied into a checking account this is very prone to happen. In addition, the advantage is that it generates interest while sitting in the savings account when untouched.
How: How much should an emergency fund have?
For this question there isn’t always a straightforward answer. I have heard of 1 month, 3 months or even 6 months worth of expenses saved. I have also heard of using figures like $1,000 – $5,000. I personally keep set my goal at $1,000 just because it’s a nice round figure and also because it covers a month worth of expenses at the moment. When I leave graduate school and start a family, I am sure that number will go up. The most important factor here is that you set a minimum that will give you peace of mind.
I’m hoping that I have somehow convinced you about the relevance of this very important financial tool or at least initiated some thoughts into starting your own emergency reserve. When crisis happens, you will have your own Red Cross to lean on.