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Wednesday, February 2, 2011

Why it's important to know how much money you need for emergencies

Emergencies can either be a one time event or a semi-perpetual event lasting several months. Examples of short term emergencies are a whole in the roof or a flat tire. A long term emergency may involve losing a job, an unexpected medical expense. If saving money isn't your preference, buying jewelry or an asset that retains value for the sole purpose of reselling it if an emergency comes up allows you to enjoy the benefits of that product while having something valuable to sell in the case of an emergency.

Saving for a rainy day with an emergency account is good financial practice
Emergency accounts prevent having to take out loans
The exact amount one needs for emergencies really depends on lifestyle and the type of emergency. If it's just a short term emergency like fixing a hole in the roof anywhere from $100-$3000 may be needed. Or perhaps it's a flat tire, then the cost of the new tire and installation would be about $75-$125.

It is difficult to predict an emergency and what type it will be but it is not impossible to try and prepare for one. Knowing ahead of time what potential emergencies may crop up could help in determining how much one should put away in a short term emergency fund.

For long term emergencies more money will have to be saved. This can involve a major shift in life, career and living situation. Planning for a long term emergency is a little more involved than a short term emergency as more costs are involved. The expense chart below helps with this.

To calculate how much you need for an emergency add up the most obvious and typical of monthly expenses. To do so obtain your most recent bill and/or average monthly payment for each bill. If the bill does not apply just enter nil or $0.00. After completing the monthly expenses add them up for a total monthly expense, when you're done multiply this by 6 for a bi-annual emergency expense fund and by 12 for an annual emergency expense fund.

While it is not always easy to save enough money to live for 6 months or a year this is what financial advisers often recommend for a savings goal. The reason having savings for 6 months to a year is to allow one enough time to reestablish an income and sort out financial and personal issues that may constitute an emergency. It can take time to save enough money for an emergency fund. By saving slowly for such an emergency the stress of having to come up withe money all at once can be reduced. If it's hard to find the money consider cutting costs in your budget and relocate the money into the emergency fund.

To illustrate the above, if you don't watch a lot of television, you could consider canceling your cable bill and use that money to finance your emergency fund. It is important to know how much you will need so that if the time comes and you need the money you won't fall short at a crucial financial turn in your life.

Knowing how much to put away for an emergency is an individual choice based on lifestyle, adversity to financial trouble and planning style. It may be not necessary to have an emergency fund if one has an unused credit card solely for that purpose. Knowing how much the credit limit should be depends on some of the above scenarios. One may also want to have both a short term and long term emergency fund.

Image license: 401(K) 2012, CC BY-SA 2.0