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Saving wisely: emergency fund

Emergency funds are savings specifically set aside to cover unexpected costs, like medical bills or car repairs. They are important because they can keep you from falling into debt or being unable to pay your bills if something unexpected comes up. Created by Sal Khan.

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Video transcript

- In life, there are things that we expect and there's other things that we don't expect. When we think about it from a finance point of view, the things that we might expect is, okay, we're going to get a regular paycheck because of our work and we're going to have regular payments for things like our rent or maybe our car payment or insurance. But then there's the unexpected things that for the most part, most of us wish don't happen. I guess there could be unexpected positive things as well but unexpected negative things are maybe your car breaks down, and that's pretty important because your car breaking down isn't just a nice to have thing or nice thing to fix. You probably need your car to get to work and make your money. You might have an unforeseen medical expense for you or a family member that you have to pay and it could actually affect how much income you or your family's able to get if you have to take off of work because of that medical event. And so because of that, it is very good to save for a rainy day and have that emergency fund. Now, most experts will tell you that you should have an emergency fund that's equal to about three to six months of your needed expenditures. We've talked about the 50, 30, 20 rule, which is 50% on needs, 30% on wants 20% of your after tax income that you're bringing in for savings. And that savings, first and foremost, should be for an emergency fund until you have a nice emergency fund. And then you could think about other things. So let's say there's a situation where your needs are $2,000 a month. You know, that's your rent, your car payment, your insurance, your groceries, the core groceries that you really, really need. If it's $2,000 a month, then an expert would say, hey, you need three to six months there. So that would be six to $12,000 of an emergency fund. If for whatever reason you lose your job, your car breaks down, you have to help out a family member, then you're going to have some reserves to be able to weather that actual storm. Now, above and beyond that, obviously it's even better to save and then you can also think about that as even a bigger emergency fund or even put it other places. But it's really important to keep this type of money around. Otherwise, yeah, you could find yourself in a tough situation.