Emergency Funds: What It Is, Why It Matters and How to Start Saving

 

Financial emergencies — we’ve all been there, and they usually come at the worst possible time. Maybe you just had your hours cut at work and that’s also when your kitchen plumbing decides to call it quits. Or you finally finished paying off debt, only to have your car break down.

Life’s curveballs are stressful, but you can safeguard yourself against financial stressors by planning ahead. That’s where emergency funds come in. When you set cash aside, you’re essentially buying yourself freedom from future worry.

And you can build an emergency fund for yourself. Here’s everything you need to know to get it done:

 

What Is an Emergency Fund?

An emergency fund is a bank account that you use to set money aside for a significant and unexpected necessary expense. You may have heard it referred to as a rainy day fund. Here are some situations when you might find yourself tapping your emergency fund:

• Paying a medical bill due to an unexpected illness or injury
• Replacing a major appliance in your home that is no longer functional
• Performing other necessary and unexpected home repairs
• Paying for car repairs after an accident
• Covering routine expenses after a job loss
• Paying vet bills and medical expenses for pets

 

How Much Money Should You Have in an Emergency Fund?

The emergency fund amount that you should aim for depends on your lifestyle and cost of living. Most financial experts recommend putting away three to six months of living expenses in your emergency fund. This should be enough to cover your routine expenses if you lose your job and should also be enough to cover some other unplanned expenses. However, that amount isn’t realistic for everyone and it’s more important to start saving what you can rather than get hung up on a specific number.

 

Is $1,000 a Good Emergency Fund?

Any emergency fund amount is good, no matter what your financial situation is. Even if $1,000 isn't enough money to cover all your living expenses, it can certainly help out if you find yourself with unplanned bills. If you need more than what’s in your emergency fund, you can explore other methods such as borrowing money from a friend or using credit. By having some money in your emergency fund, you’re able to reduce the amount that you’ll end up owing or paying on interest.

 

Is an Emergency Fund Worth It?

No matter what your financial goals are, having an emergency fund is worthwhile. The truth is that we never know what is around the corner, and unexpected expenses can pop up at any time. It's something that many people have experienced firsthand due to the unexpected events surrounding the coronavirus pandemic. Having an emergency fund can provide peace of mind because you know that you’re prepared.

An emergency fund isn’t a cure-all when you’re in a challenging situation. But it can provide a cushion between you and some really tough financial spots.

 

Why Do I Need an Emergency Fund?

Simply put, emergency funds are a good idea because you never know what could happen. Life could be going well, and then suddenly you’re faced with unplanned expenses. The need for emergency funds isn’t limited to negative events, but even positive life events like having a baby or landing your dream job and needing to relocate can bring unexpected costs, creating stress in your life and decreasing your financial well-being.

Without an emergency savings account, you might dip into your long-term savings, potentially derailing your future plans. If you have an IRA or other retirement account, you may feel you need to take a loan or withdrawal from it to cover your immediate expenses. But you’ll miss out on earnings while you’re repaying the loan and you may have to pay penalties on your withdrawals. By having a separate emergency fund, you can increase your overall financial stability.

 

How Much Should I Put In My Emergency Fund Per Month?

It might seem daunting, but once you know the emergency fund amount you need, you can figure out a plan to meet that goal. You don’t want to stretch yourself too thin by putting as much as possible in your emergency fund each month. But, through budgeting, you should be able to calculate how much money you can comfortably sock away each month.

 

Should I Use My Emergency Fund to Pay Off Debt?

You should think of your emergency fund as something entirely separate from your debts. Many recommend keeping your emergency fund for a large, unexpected expense. That way, when something comes up, you can save money by paying for it up front rather than having to take on additional debt.

That said, if you focus on putting all of your extra money into your emergency fund instead of paying off debts, you could be hurting yourself in the long run. It’s a good idea to find a balance between the two, so you can minimize the amount of interest you incur on credit cards and loans.

 

How to Build an Emergency Fund

1. Calculate your monthly expenses

This is a great opportunity to evaluate your budget and see whether you can cut a few items to save some extra cash.

2. Set a monthly savings goal

After you’ve figured out your monthly expenses, you’ll know how much money you have leftover each month. Decide how much you want to dedicate to building your emergency fund and make this your monthly savings goal.

3. Decide where to keep your emergency fund

You’ll want to keep your emergency fund separate from the rest of your money. Any credit union or bank should be able to help you with this. A high-yield savings account could be a great option to store emergency funds because it can earn more interest than regular savings accounts. A regular savings account also works just fine, and if you have your checking account and savings account with the same bank, you may be able to set up automatic transfers after each payday.

Once you’ve funded your emergency savings, don’t stop there. Make sure to replenish the fund after using it (and just as when you started, take it slow, you aren’t going to replenish it all at once). Be sure to turn your attention to other savings opportunities, too. Maybe now you can think about saving for recurring expenses that you often forget about, like your car registration or annual memberships. Or you can set aside money for long-term goals, such as buying a house or going back to school.

The important thing is that you make saving a habit, no matter your goals, how much you earn or how long it might take you to achieve them. We cannot predict life’s curveballs, but we can set ourselves up to confidently handle them when they arrive.

 

This content provided is for educational and informational purposes only and does not constitute financial or legal advice. RISE is not acting as a credit counseling or repair service, debt consolidation service, or credit services organization in providing this content. RISE makes no representation about the reliability or suitability of the information provided – any action you take based on this content is at your own risk.