What is an Emergency Fund?
An emergency fund is a reserve of cash that’s specifically set aside for unplanned expenses. It can be used for both small and large expenses that aren’t part of your monthly budget but still need to be paid. An emergency fund is commonly used to cover home repairs, car repairs, medical bills, or the loss of income.
You never know what life may throw at you next, so it’s important to be prepared. Even a minor financial shock can set you back months and have a lasting impact on you and your family. Relying on credit cards or loans can lead to that debt growing and becoming harder to pay off. It might even lead to you needing to pull from another type of savings account, like a retirement fund, to cover these unexpected costs.
How Much Should Be In My Emergency Fund?
There’s no set rule for how much should be in your emergency fund. Every person or family is different, and your emergency savings fund should reflect your personal needs. The general rule of thumb, however, is to have 3-6 months’ worth of your necessary expenses saved.
So to find out how much you’ll need, think about what you have to pay for every month and add it up. Take that number and plan out your savings budget. If you’re living paycheck-to-paycheck, saving money can seem impossible. It’s okay to start saving with small amounts, even just $10 a month, and expanding that as you regularly meet your savings goal.
How to Build an Emergency Fund
Building savings is easier when you’re able to continuously put money away. But that may sound like a lot. So here are a few ways to help you get into the flow of regularly putting savings into your emergency fund.
- Adjust Your Savings Habits: A little can go a long way, so always aim to put money in your savings. An easy way to ensure this is to set aside money at the first of the month with an automatic deposit so it doesn’t become an afterthought.
- Bring Down Your Budget: Ask yourself, is my budget the best it can be? Reevaluate where your money is going and why. Maybe you have three streaming services, but only use two. Cutting out things you don't need can add up over time.
- Cache Your Cash: Separate your funds to help avoid temptation. Put your emergency fund in an account that lets you earn extra interest and is away from your usual spending money. Put your bonus and your tax refund in that same account to help bolster your savings.
- Celebrate Your Successes: Take a moment to be proud of yourself and celebrate when you reach your savings goal! You’ve stuck to your newly found savings habit and deserve a treat! This can help keep you motivated to meet your goals in the future.
7 Tips to Building an Emergency Fund
- Cut Back On Dining Out: Eating out is convenient and fun, but it can also be incredibly expensive. By planning out your meals, preparing your own food and even bringing a brown bag lunch to work, you can save a lot of money. Even if you cut back on eating out just a few times per month, you can save a decent amount of money that you could put into a savings or emergency fund for your future rainy days.
- Take a Wait-and-See Approach on Expensive Items: It’s easy to spend money on things that will bring pleasure now, but bust your bank account later. It’s human nature. So, instead of always buying impulse items right away, consider implementing a 30-day wait-and-see approach. This means thinking about your potential purchase for at least 30 days before making the transaction. Then you can decide if the purchase is really necessary. You may often decide you didn’t really need that item in the first place, which will save you money.
- Find a Savings App: Savings apps make it easy to find coupons and rebates, and even track your spending to remind you when you’re over budget. Apps can offer easy ways to set aside a few dollars every month for an emergency. You can start by looking for apps from your favorite stores. Many large retailers have rewards apps that can save you money on things you already purchase anyway. However, be sure to avoid talking yourself into buying discretionary items you don’t need. It’s easy to justify unnecessary purchases, especially when there’s a great deal staring you in the face.
- Review Previous Unexpected Expenses: View your bank statements for the past year and calculate how much you’ve spent on emergencies. These can include unexpected car repairs, doctor’s visits, or emergency out-of-town trips. Reviewing these will give you a good idea of what to plan for in your future fund. Of course, you can’t always predict every emergency that will pop up, but this will give you a reasonable starting point.
- Set a Savings Goal: Take the information you’ve learned from reviewing your past emergencies and use it to set savings goals. Target your goal in dollar amounts. For example, starting with $1,000 in your emergency fund will cover most expenses. Then, based on your research, decide how much you can set aside every month to cover unexpected costs throughout the year.
- Find a Secure Home for Your Savings: If you don’t already have a savings account, open one. Placing your money in a separate account is a great way to tell yourself that certain money is off limits. You could even open up a separate savings account for your emergency money. Doing so can help you avoid the temptation to dip into your savings for non-emergency purchases.
- Fund Emergencies (and Savings) First: With so much of your money spoken for (in the form of bills, rent, mortgage, and more) even before your paycheck comes in, it might seem counterintuitive to live by the policy of paying yourself first. But, the best way to afford your emergency purchases is to fund your savings and emergency accounts before anything else. If your employer offers direct deposit, use it to allocate a certain amount toward savings and emergency right away.
When to Use Your Emergency Fund
Having money just sitting there can be tempting. Set guidelines for yourself on what’s a true emergency. Not everything that breaks warrants using your savings to replace it right away. You can wait to buy a new TV, but you can’t wait to fix a car if that’s how you get to work. Here are some common emergency expenses.
- Protecting Income: No one wants to think about losing their income. Unfortunately, it’s always a possibility. Having a cushion that will cover your necessary expenses is important. Being prepared can give you time to find a job without panicking about living costs.
- Home & Vehicle Repairs: Knowing that you have a way to keep a roof over your head when things get tough can be everything. An emergency fund will help ensure that you can not only keep your house, but keep it from falling over. The same applies to your car. Not every city has a system that allows you to rely on public transport, so it’s important that you can keep your car running.
- Medical Emergencies: There’s no telling what will come around the corner. Health is a fickle thing, and health care is expensive. Being able to pay some of the costs upfront that insurance won’t cover will help you keep one step ahead of unnecessary debt. Even if you need to take out loans in the long run, an emergency fund will help give you the time to figure things out so you can avoid rushing and risk making a bad financial decision.
Summary
Emergency expenses have a way of throwing a wrench in your financial planning that can be difficult to overcome. So, when it comes to planning and saving for the unexpected, it’s always better to be safe than sorry. Even if you can’t always avoid life’s little mishaps, planning (and saving) for them can give you peace of mind now and help you get back on your financial feet in the future.