What is an Emergency Fund?
An emergency fund is a stash of money set aside in a specific account for unforeseen or unexpected circumstances. Generally, these funds are cash or illiquid so that they may be accessed immediately.
Some of the following are the most common things that emergency funds are used for:
- Vehicle repairs
- Loss of employment
- Major appliance repairs
- Medical emergencies
- Family situations
- Missed flights
Having an emergency fund set aside can help you to stay financially secure while providing a debt free safety net in case a situation arises.
Why Do you Need an Emergency Fund?
You need an emergency fund that can keep your head above water in unexpected times. This money can serve as a buffer between your living expenses and getting through a crisis without the need to pursue a personal loan, borrow against your paycheck, or go into additional credit card debt.
According to research, more than 40% of people don’t have the means to protect themselves from an emergency costing $400 and would have to borrow money in order to get through it. The worst thing that can happen to someone already in a bad financial situation is to go into additional debt.
How Much Should you Save?
When it comes to how much you should save for an emergency fund, there are a couple of different schools of thought. One is that you should have a minimum of $1,000 for a mini or short term emergency fund. The other is that a true emergency fund should contain at least 3 to 6 months of living expenses. However, how much you ultimately save is going to depend on factors such as your monthly income, budget, and likelihood of being able to cover things if something goes awry.
Where to Keep your Emergency Fund
Unlike your regular income or investments, your emergency fund should be kept in an account at your local bank or credit union. This way, you can easily access the cash without having to go through paperwork or pay costly tax penalties at the end of the year, which can make your situation worse.
Some of the best ways to stash your emergency fund are in the following types of accounts:
- High Yield Savings Account (HYSA) – A savings account that pays a high interest rate over the year for money accumulated inside the account. Funds are federally insured and can be accessed with a simple transfer.
- Credit Union – A savings or checking account at a credit union often comes with additional member benefits and offers competitive interest rates in exchange for local investment .
- Money Market Account – A money market account is a hybrid between a checking and savings account. They also provide higher deposit thresholds, more flexible account options, and usually no overdraft fees.
How to Start an Emergency Fund
Starting an emergency fund when you are not used to saving can require a bit of creativity. However, the following steps will help you to assess your finances, start putting money aside, and create a fund that will allow you to be financially prepared.
1.) Determine how large you want your fund to be
Before you begin saving for an emergency, you want to decide how much money you can afford to save over a specific time frame such as a year to get started.
2.) Divide the amount into smaller goals
Once you have your savings number in mind you can divide the amount into smaller chunks such as monthly amounts that align with your budget. You can even split the monthly goals into weekly or bi-weekly totals depending on how often you are paid.
3.) Create an automatic savings transfer
A great way to stay on track with creating your emergency fund is to set up an automatic savings transfer. This way you will automatically deduct a portion each month and learn to live off the rest since you won’t actually see the money before you have a chance to spend it.
4.) Look for ways to maximize
Once you meet your original goal for an emergency fund, you may be inclined to add some additional funds. Bonuses such as tax refunds, salary increases, inheritances, or other financial windfalls are a hassle free way to bulk up your savings or create an additional fund altogether.
5.) Readjust the amount periodically
It’s always a good idea to do a quick financial check-in at least twice a year. If you find that you’ve saved enough money, or your household income has decreased, you can adjust your savings contributions up or down so that it’s in accordance with what you are actually bringing in.
Regardless of how much you are able to save or an emergency, having the money will provide you the piece of mind to get through a short-term financial issue with all of your living expenses still intact.
Example of an Emergency Fund
An example of an emergency fund is when your monthly take home pay totals $6,000. If you decide that you would like to save 20% for unexpected expenses each year, then you would put away $1,000 per month. At the end of six months, you would have $6,000 set aside as a financial buffer, without impacting the other $30,000 you could spend on living expenses.
Frequently Asked Questions
Should I Use My Emergency Fund to Pay Off Debt?
Emergency funds should not be used to repay your debts. If you use the money for any unintended reasons, then you may find yourself in a rut when you actually need to use the funds.
What is a Good Starter Emergency Fund?
A good starter fund is one that will allow you to save at least $1,000. However, if you have less income or a high amount of expenses then $500 would be reasonable initially.
How Much Should I Put in My Emergency Fund Each Month?
The amount of money that you should put into your emergency fund each month is based on the amount of income you have coming in compared to your living expenses. Deciding on a fund based on a percentage of each paycheck can be a good basis to getting started.
Emergencies happen as a part of everyday life. However, they also strike when it’s least expected. In order to save yourself a financial headache that can have a domino effect on your budget months to come, take a look at your finances and put together an emergency plan.