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 when your kitchen plumbing decides to call it quits. Or you finally finished paying off a debt, only to have your car break down.
Life often doesn’t seem fair, 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:
Table of contents:
What Is an Emergency Fund?
An emergency fund is just what it sounds like — a rainy day fund for the unexpected. Even the thriftiest spenders and most careful planners can’t anticipate everything. It sits untouched until you need it to cover a big medical bill or urgent car repairs so you can get to work.
Emergency funds are different from regular savings accounts and sinking funds. Your regular savings account is for long-term expenses, and sinking funds are for specific expenses you want to plan for (such as Christmas gifts or a special vacation). Emergency savings are for the unplanned.
Who Needs an Emergency Fund?
Everyone. The COVID-19 pandemic was a harsh reminder for many of how quickly our circumstances can change. When the new year started back in January, most people didn’t anticipate losing their jobs or having to social distance for months at a time. In fact, back in January, no one even knew what social distancing was.
But it doesn’t take a pandemic to shake up your world. Life could be going well, and then suddenly you’re faced with an unforeseen expense. Even in the best cases — you find out you’re going to have a baby, or you land your dream job and need to move across the country right away — unexpected costs can create stress in your life and cause strain on your finances. Without an emergency savings account, you might dip into your long-term savings, derailing your future plans. If you have a retirement account, you may feel you need to take a loan or withdrawal from it to cover your immediate costs. But you’ll miss out on earnings while you’re repaying that loan, and you may have to pay penalties on your withdrawals.
People often turn to credit to cope with emergencies, but this can create problems of its own. If you have a high-interest credit card, you could end up paying more than you initially intended for the expense. And if you’ve lost your job or had your hours cut, it could take you even longer to pay down your credit card balance. Worst case scenario, you can’t make your payments at all and you end up in default, which can seriously hurt your credit.
An emergency fund isn’t a cure-all when you’re in a tough situation. But it can provide a buffer between you and some really tough financial spots.
How Much Do You Need in an Emergency Fund?
There isn’t a recommended emergency fund amount because your money needs are different from everyone else’s. Instead, experts recommend saving three to six months’ worth of expenses so that if you are out of work for an extended period, you can still cover your essential costs.
If saving three months’ worth of expenses seems impossible, don’t worry. You don’t need to have a fully-funded account overnight. It’s better to start small and set aside what you can when you can.. Even $100 or $300 saved will ease the burden in an emergency and reduce the amount of money you may end up needing to borrow or put on credit.
How to build an emergency fund
The first step toward building an emergency fund is to figure out 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.
Your budget should include essentials, such as rent, utilities, groceries, gas, and prescriptions. If you can afford it, you may want to include a small buffer for miscellaneous costs) and entertainment expenses such as takeout or streaming services. But make sure to keep the buffer small, because the bigger your budget, the longer it will take to fund your emergency savings account.
If there are costs or non-essential services eating up your income, such as subscription boxes or monthly fitness programs you don’t use as often as you expected, consider canceling them. Not only can you put the money you save into an emergency account, you’ll have more cash on hand month to month once that account is funded.
Where Should You Put Your Emergency Fund?
If you have access to a high-yield savings account, that’s a great place. Hopefully, the money will sit there for a long time between withdrawals, and it will earn more interest in a high-yield account. Lots of banks offer these, so look around online for an option that suits you. Or, check with your current bank to find out whether they can open a high-yield account for you.
You can also put your emergency deposits into a regular savings account. If your checking and savings accounts are linked, you can easily transfer money from one to the other. You may even be able to set up automatic transfers every time you get paid so you’re consistently contributing to your emergency cash.
When it comes to reaching your savings goal, small but consistent deposits are more important than hitting your target at lightning speed. If you can fully fund your savings account right away, that’s great. But most people can’t do that, which is fine. Decide how much you can contribute on a monthly basis and start there. Remember, any money saved is better than no money saved. And when an emergency comes up, you’ll be thankful for anything you’ve socked away.
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 don’t need to refill it in one day). But turn your attention to other savings opportunities as well. 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 what your goals, how much you earn or how long it takes you to get there.