Your next emergency might be right around the corner, or it might not happen for years to come. But that’s the thing about emergencies — they’re nearly impossible to predict and are almost always inconveniently expensive. The best thing you can do to be financially ready for an emergency is to prepare before it ever hits home.
What is an Emergency Fund?
An emergency fund is a reserve of cash set aside for unexpected, emergency expenses. These expenses could be anything, from car repairs to medical bills to the loss of income. An emergency fund is there so that you can afford your needs, but not meant to supplement your wants, during tough times.
Why is an Emergency Fund Important?
When you experience a financial emergency, applying for a loan or putting the expenses on a credit card may seem like a good idea at the time. But in the long run, both of those choices can be expensive and put a strain on your finances in the long term.
While nobody can predict the future, there are always things you can do to be prepared for whatever might come your way. An emergency fund is the best way to be financially prepared for whatever the future holds. When the day comes that your car breaks down or your basement floods, your emergency fund will be there to help you out without any additional financial strain. It can give you the peace of mind that an unexpected expense won’t completely disrupt your finances.
When Should I Use My Emergency Fund?
Emergencies will vary from person to person, but the general rule is that an emergency fund is there for unexpected expenses that you need to pay for immediately. For example, the TV breaking is unfortunate, but not an immediate need — you can save up money over time to get a new TV. If your car breaks down and that’s your primary means of transportation to and from work, you’ll need to pay for those auto repairs.
Only you can decide when an unexpected expense merits a withdrawal from your emergency fund. Use your best judgement to decide what is worth depleting your fund for. And make sure that as soon as you use your funds, you begin rebuilding it back up for the next unexpected expense.
How Much Should Be in My Emergency Fund?
When it comes down to building an emergency fund, the more money you can have, the merrier. But the general rule of thumb is 3-6 months' worth of living expenses. If that seems like too much for you at the moment, think about the most common unexpected expenses you've had in the past and how much those cost. This may help you set an achievable goal that should still help with emergencies.
It’s common for people to be overwhelmed at the idea of saving thousands of dollars right away for an emergency fund, but emergency funds can be built up slowly over time. And you can change your goals as you’re able to save more money. So, if you’re new to building an emergency fund, you might start with a goal of $500. Then, once you reach that, you up that goal to $1,000, and so on.
Where Should I Keep My Emergency Fund?
Every savings account differs, but you should at least consider saving your emergency money in an account that can earn interest. Remember, your next emergency might not happen right away. So you might as well earn interest on your emergency savings while you enjoy an emergency-free moment.
You should also think about keeping your emergency savings account separate from your regular savings and checking accounts. You don’t want to be tempted to use it for other, non-emergency expenses. An added bonus is if you can set up automatic deposits from your paycheck into that fund so that you don’t have to do anything to keep building your fund over time.
How to Build an Emergency Fund
Just like how people are different, the best ways to save money will vary based on everyone’s own financial strengths. But here are some key things to keep in mind while working toward building your emergency fund.
- Determine Your Emergency Fund Goal: Every emergency fund will be different, but in general, it’s a good idea to start with a goal. As mentioned above, your goal will depend on where you’re at financially. If you’re new to building an emergency fund, start with a goal of $500-$1,000. If you’re an expert at saving an emergency fund, set a goal to have 3-6 months’ worth of your expenses covered.
- Make A Budget: If you can afford to put away 3-6 months’ worth of expenses all at once, that’s great! However, most people will need to build up their emergency savings over time. Plan to set aside a portion of your income every month or with each paycheck. Be sure to put this amount in your budget and prioritize your savings each month.
- Set Up Direct Deposit & Automate Your Savings: Just like money comes in (direct deposit) and out (automatic bill pay) of your account regularly, you can automatically transfer a portion of your paycheck into your emergency account. This makes it so you’re less likely to be tempted to use it or forget to transfer it to your savings account. Talk to your employer or HR team to see how you can transfer a portion of your paycheck to a separate savings account.
- Increase Your Savings & Make Regular Contributions: As mentioned above, you can start with a savings goal and, once that’s achieved, you can increase that goal. You don’t need to stop saving once you’ve reached your first goal. Ideally, you should consistently add to your emergency fund, even once you achieve your goals. Having extra money in your emergency is a great problem to have! You’ll just be extra prepared for whatever the future holds.
- Save Unexpected Income: Maybe you got a tax refund, a bonus at work, or just an unexpected gift from a family member or friend. Use that unexpected income (or a portion of it) to build up your emergency savings. It won’t throw off your regular budget, and it’s a great way to get started on building an emergency fund fast.
- Be Accountable: Avoid using emergency funds for anything other than true emergencies. Don’t be tempted to use it for things you simply want, but don’t need. This also means sticking to your budget and consistently depositing money into your account each month.
How Do I Rebuild My Emergency Fund After Using It?
Most likely, your emergency fund will go up and down as you pay for different emergencies that pop up throughout your life. Keep tabs on your account and adjust your savings accordingly as time goes on. If you’ve had several emergency expenses come up all at once, start the steps all over again and keep saving for your next unexpected expense.
Summary
An emergency fund is a great way to increase your overall financial security and keep you on track to reach your financial goals. Building a healthy emergency savings will give you the peace of mind for whatever financial emergencies are down the road. To start building an emergency fund, find a savings goal that works for you and consistently add to your emergency fund over time. The best way to do this is by holding yourself accountable and sticking to a budget each month.