It’s always good to save and have that little bit extra for a rainy day. It is also good to build your credit which an help you obtain a mortgage in years to come.
Some people may splurge to get instant gratification instead of saving money. It gets even more concerning to see folks who cannot clearly distinguish the difference between an emergency fund and a cash cushion. They find it hard to differentiate between needs and wants.
Some may view them as the same thing, but they’re not. So, what’s the difference between the two?
In this post from Alpha Car Finance, we define the difference between an emergency fund and a cash cushion, and why they are both important to have.
What is an emergency fund?
In life, many unexpected things can happen. It could be as simple as someone getting sick or something as serious as a death in the family. When these unforeseen events occur, it helps when you have some money set aside. This is where your emergency fund kicks in.
To some extent, most expenses can be anticipated. For example, you can determine that your house will need some repairs at some point. You just don’t know when exactly. That’s why it’s essential to have a separate budget allocated for things like that.
How much should you save for an emergency fund?
Ideally, you should have roughly three to six months’ worth of your living expenses saved in the bank. So, in the event of an emergency, you can use these funds to cover it. If you don’t have a steady stream of income, you may want to increase your emergency fund up to nine months. This is suitable for freelancers or people who earn through commissions.
When should you use your emergency fund?
As the word suggests, an emergency is an unexpected situation that needs immediate attention. So, if something happens that affects your health or prevents you from working and earning money, you can use your emergency fund.
What is a cash cushion?
Sometimes, no matter how hard you try sticking to your budget, you just can’t help but go over it. It could be a fantastic deal that you saw on that designer bag you’ve always wanted, an impromptu family holiday, or something similar. Whatever it is, your cash cushion is what helps you fill in the gaps in your monthly expenses.
How much should your cash cushion be?
Your cash cushion doesn’t have to be as substantial as your emergency fund. So, it could be anywhere between $300 to $600. Also, a cash cushion is easy to replenish since it does not require you to set aside a huge amount.
When should you use your cash cushion?
Here’s one example of when it is appropriate to use your cash cushion. You decide to treat your wife for her birthday. You take her to a fancy restaurant and buy her a special gift. So, you go a little bit over your monthly budget. A cash cushion will help you cover these types of expenses.
We all need to prepare for the unexpected. Having an emergency fund and a cash cushion can mean the difference between surviving a minor bump in the road or helplessly tumbling into debt. If you have some thoughts to share, we’d love to know.