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Establish an Emergency Fund That Works for You
Keeping money in a dedicated emergency fund may help prepare you for unexpected expenses.
Did you know that nearly 40% of Americans can’t afford a $400 emergency? Between rising inflation, increased housing costs, and wage stagnation, it’s no surprise. But an emergency fund could help you prepare for unexpected situations.
There’s more to establishing an emergency fund than simply deciding you need one. You need to open the right type of savings account and determine your goal based on your lifestyle.
Let’s look at how emergency savings funds could help you be ready if you encounter a lean time.
Key Takeaways
Emergency funds are safety nets that help cover expenses during unexpected financial emergencies.
Most people should aim to save between three and six months of living expenses in their emergency fund.
Having a separate savings account for your emergency fund may reduce the risk of using the money for non-emergency expenses.
What Is an Emergency Fund?
An emergency fund is a safety net that could help you cover unexpected expenses like medical bills, major car or home repairs, or even losing your job. These savings are separate from your other savings and should only be used for emergency purposes.1
It may be easier to open a dedicated savings account for your emergency fund. By separating your emergency fund from general savings, you may reduce the temptation to spend it on non-emergency situations.
Emergency Funds Vs. Rainy Day Funds
When people think of emergency funds, they often mistake them for rainy day funds. Though both help cover surprise expenses, they have different purposes.
Emergency funds exist to support you through a major financial crisis, such as a job loss. Rainy day funds typically cover smaller unexpected expenses, like replacing an appliance or covering an unexpected vet bill because Fido ate a squeaky toy. Again.
Since rainy day funds cover smaller expenses, most people don’t earmark as much money for them as they do emergency funds. Both funds are worth having, but you probably want to keep more money in your emergency fund.2
Reasons to Have an Emergency Fund
Building your savings is a great way to improve your financial well-being, but having a specific emergency fund may be a good idea even if you have significant savings for general purposes.
Some benefits of creating a dedicated emergency fund may include.3
Lower stress levels. Having an emergency fund may result in less stress over money since you won’t have to wonder how you would pay for unexpected expenses.
Reduce impulse spending. Building up dedicated savings may make you less tempted to use these funds for impulse purchases.
Avoid debt during financial hardships. These funds may help cover unexpected costs, which may reduce the need to take out a personal loan or wrack up additional charges on high-interest credit cards to make ends meet.
Emergency Fund Calculator: How Much Should You Save?
Experts recommend having three to six months of expenses in your emergency fund, but the exact amount you need depends on your financial situation.4
To help set your goal, follow these steps:
Think about the expenses you have each month.
Remove any nonessential expenses you’d cut out during an emergency like eating out or streaming subscriptions.
Total the remaining numbers up.
Figure out how long you expect an emergency to last. This may be several months.
Multiply your total essential expenses by the number of months you expect your emergency to last.
Let’s look at how this might play out in real life. Say your essential monthly expenses look like this:
Rent/mortgage payment: $1,500
Utilities (water, sewer, electricity, etc.): $300
Groceries: $500
Insurance: $100
Car payment: $320
Your total essential monthly expenses come to $2,720. To save the recommended three to six months’ worth of living expenses, you need to set aside between $8,160 - $16,320.
Revisit this goal on a regular basis or whenever you experience a major life change, such as having a child or getting married. As your essential expenses change, you may need to set more aside.
Where to Keep Your Emergency Funds
Many people find it easier to keep their emergency funds in a separate savings account rather than comingled with their regular savings.
When setting up a dedicated emergency fund, make sure you’re choosing the right account for your needs and goals.
Ideally, you want these funds to be easily accessible since emergencies could happen at any time. You also want your money to be safe and to grow over time at a competitive rate.
As you search for a savings account, consider these key factors. The account should:
Be NCUA/FDIC insured, so your money is safe even if the bank fails.
Have high rates, expressed as Annual Percentage Yield (APY), so your money grows faster over time.
Be easily accessible. Look for features like digital transfers or automatic deposit so you’re able to add to or withdraw from your account as needed.
How to Build an Emergency Fund
Setting money aside on a regular basis is tough if you’re not sure where to start. Here are a few tips to help you build your emergency savings.
Set a clear goal: Calculate how much you need to have on hand for a crisis.
Track your progress: Tracking may help you stay motivated and encourage you to keep saving rather than spending the money you set aside.
Use automatic transfers: Remembering to set money aside is tough when you’re juggling your work, social, and personal responsibilities. Instead, set up automatic transfers each month and put your savings on autopilot.
Choose a high rate: Higher rates mean the money you keep in your savings account grows faster.
Keep these tips in mind and you’re on your way to building your emergency fund.
When Should I Use My Emergency Fund?
As we mentioned earlier, emergency funds should be used for significant financial difficulties. This means you want to avoid using the money for spontaneous purchases like buying a new TV or stocking up on this season’s latest sneaker styles. (A splurge fund could help you handle those types of purchases!) But every situation is unique and what qualifies as an emergency to one person may not be for another.
Think about what you’d consider to be an emergency. You may even want to write a list that you could consult if you’re struggling to determine if a situation qualifies.
An emergency may be something like losing your job, getting injured and having medical bills to pay, or your car breaking down and needing thousands of dollars in repairs.
Use your funds to cover costs that are emergencies to you. Just be sure to build your fund back up after the situation passes so you’re prepared for the next one.
Final Thoughts
Establishing an emergency fund may be one of the easiest ways to set yourself up for financial stability in the long run. By creating this fund now, you’re more likely to be able to build up reserves that you could use to help cover emergency expenses when they pop up.