3 Good Reasons to Maintain a Household Emergency Fund
Managing money calls for a great deal of planning, but flexibility is another key feature of effective personal financial management. Although most spending needs can be anticipated well in advance, flexibility in your personal budget allows for unexpected expenses. And an emergency fund gives you a cash cushion to fall back on, when extraordinary demands emerge. If, like many households, your emergency resources fall short; consider the following good reasons to establish and maintain a personal contingency fund.
Create your own safety net
As you plan your budget and account for myriad household spending demands, efforts should be made to reserve savings for an emergency fund. For the best results, sequester the resources in a separate account, rather than comingling emergency savings with other incoming resources. That way, you’ll be less tempted to unnecessarily draw from the account for ill-advised purchases. If possible, establish an interest bearing fund, to help your emergency resources grow. And make it as inconvenient as possible to access the money – even setting-up your contingency account at a separate bank, away from your primary financial institution.
1. Personal Insurance
Regardless of the cause of financial difficulties – and there are many; a contingency fund acts as an insurance policy, preventing a manageable issue from snowballing into a bigger problem. In fact, you can use the analogy to stay on track with savings. By thinking of your emergency fund as an insurance policy, and paying corresponding premiums to your own reserve account, you essentially mirror the benefits of insurance coverage, administering the benefit yourself, rather than hiring a provider.
A personal emergency account reserves resources you can use to address these and other common financial crises:
- Temporary unemployment
- Costly car repairs
- Medical bills
- Mechanical breakdowns at home
- Job loss
- Divorce expenses
- Special property assessments
- Income tax obligations
2. Avoid Costly Alternatives
Unexpected expenses pop-up quickly, so there isn’t always time to wait for funding – money is usually needed on the spot. When an urgent demand strikes, you may find fast financing online, and it is important to recognize; certain choices make more sense than others. Credit cards, for instance, carry high interest rates and stiff penalties for late payment, making it easy to get into financial trouble overusing revolving credit. Cards also have credit limits, which may not cover your entire financing need. As a result, credit cards should be used only as a last resort. Unfortunately, without an emergency account, your options may be limited – and costly.
Though various types of loans provide funding at lower rates and with flexible repayment terms, no form of financing is as cost-effective as drawing from your own emergency reserves. In effect, maintaining emergency resources helps you avoid making ill-advised financial decisions.
3. Maintain Cash Flow
Some financial emergencies relate to specific purchases, repairs, or replacement needs. In other cases, emergency reserves are needed when income or household cash flow are interrupted. Job loss and temporary layoffs, as well as injury and disability, cause these types of unanticipated financial inconsistencies. If you are impacted by these unforeseen events, your well-funded emergency account bridges the financial gap, as you grapple with these challenging circumstances.
Many financial advisors recommend a particular savings threshold, though any progress in the right direction is better than facing financial difficulties with nothing in reserve. Finance experts commonly suggest emergency savings totaling at least three months’ worth of customary household spending. With such a lofty goal, it may take some time for you to set aside ample funds, but holding a few months’ worth of cash reserves substantially lowers your vulnerability to financial distress.
Maintaining a healthy emergency fund helps limit risk and prevents small financial problems from growing into unmanageable concerns. Not only do emergency resources cover pop-up expenses, but keeping a rainy day fund can also save you from costly alternatives.