From a job loss to a surprise hot water heater repair, a dedicated emergency fund equips you to handle unexpected and emergency expenses without having to use credit cards or take out debt. Because it can keep you financially afloat in a time of need, you generally want to prioritize this savings goal. Here’s what you need to know to make it happen.
Calculating an emergency fund
If you’re building an emergency fund for the first time, there are three things to consider when determining how much that fun should hold. An average emergency fund should be able to help you cover the following:
Nearly four in 10 adults would have trouble covering a $400 expense, according to a recent Federal Reserve survey. Some respondents in the survey said they’d borrow money if they had to cover a surprise cost. But it’s always better to avoid debt if you can — interest payments can be costly, and too much debt can impact your credit scores. Make sure you included a budget for unexpected expenses when calculating an emergency fund.
Maintain your lifestyle after a disability or illness
A severe injury or sickness can be devastating, especially if your finances were already tight covering big bills, like a mortgage, to begin with. An emergency fund can at least defray the costs and help fill the gaps until you’re back on your feet. Look at your monthly expenditures for food, housing, clothing and other related expenses. That total should give you a picture of what you’d need to get by
Benefit from peace of mind
It can be stressful to think about life’s major curveballs. Money is the second most common source of stress for Americans, but when you have reserves to fall back on, you’ll know you have a plan to help you through the worst.
If you’re trying to save while you have debt, it can be hard to decide whether to allocate extra cash to your emergency fund or use it to pay down your balance. Although you may not be able to save the recommended three to six month emergency fund right away, you should consider putting at least some cash aside to help you in a pinch as a starter emergency fund. Then, you can make smaller contributions to grow that fund over time
5 Tips for building an emergency fund
Create an emergency fund goal
The right amount for your fund depends on your financial obligations and comfort level. Many financial experts agree that saving three to six months’ worth of expenses is a solid goal. For example, if your bills and average discretionary spending add up to $4,000 a month, then aim to save between $12,000 and $24,000.
Set a monthly savings goal
Go through your monthly expenses and add up your essential bills. These commonly include items like your mortgage, insurance, car payment, groceries and utilities. Estimate how much you spend each month on discretionary purchases, such as your cable bill and one or two meals at a restaurant. Add that figure to the sum of your essential bills.
Then, check how much you earn after taxes each month. Subtract your expenses from your monthly income to figure out how much you can realistically save.
Decide how and when you’ll use the funds so you don’t end up spending the money when you don’t really need to. For example, you might decide it’s time to tap the emergency savings after a job loss or for an important home or car repair. But for each emergency, consider other solutions before tapping your savings. It should truly be your last resort.
Set up an account
The best account for an emergency fund would be a savings account. Stashing your savings in its own account will help you avoid the temptation to spend it. Keep the savings liquid, meaning you can access it whenever you need the funds. The most popular options include high-yield savings accounts and money market accounts. But first, check the rules on how often you can make withdrawals from these types of funds.
It’s also important to not rely on your investments to cover unexpected expenses, but if the temptation of investing your emergency fund is too strong to resist, some experts recommend investing short-term savings differently than long-term savings.
Saving money isn’t always the most exciting experience, but there are ways to make it a seamless part of your everyday life.
- Automatically transfer money to your savings account each time you get paid. Some employers can also set up direct deposit so part of your paycheck is immediately allocated toward your goal.
- Get a temporary part-time job or start a side hustle to earn extra cash for your savings.
- Save coins in a jar and transfer them regularly to savings.
- Redeem your credit card rewards for cash and add it to your savings account.
- Save your tax refund and other windfalls, such as bonuses at work.
Everyone should try to save for the unexpected and set aside money for a rainy day. Whether your reserves amount to a few hundred dollars or six months’ worth of expenses, an emergency fund can be the difference between getting through a short-term financial setback or getting into debt.
So, is it bad to not have an emergency fund?
In short, yes! Rest assured that it may take time, but it’s possible to build a solid safety net to protect you and your family for the ups and downs life has to offer.