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Most everyone experiences financial difficulties in their lives, and that’s precisely why financial advisors and financial planning experts recommend individuals build an emergency fund. An emergency fund is a personal savings reserve set aside in the event of future unexpected expenses or mishaps.
Emergency funds should always be available as liquid assets so that you can access them at a moment’s notice.
Why Do I Need an Emergency Fund?
While no one wants it to happen, unfortunately, financial hardships or enormous unexpected costs sometimes occur. For example, people are suddenly let go from their jobs due to recessions, or their cars break down or they incur significant medical debts after an accident or diagnosis.
Whatever the reason, the one consistent factor is that these are always a surprise.
According to the 2017 Report on the Economic Well-Being of U.S. Households, approximately 40% of Americans couldn’t cover a $400 emergency. And one in three Americans has zero budget for car repairs. Considering how likely it is that a $400 emergency or car repair will occur at some point within your average year, this is highly concerning.
Without an emergency fund in place, you might turn to dire solutions. For example, you might go to a payday lender, who would have very high interest rates. Or you might not be able to pay rent and be evicted.
Whatever the case, even a small setback, like an unexpected bill, can often send someone spiraling into debt. An emergency fund is like a shock absorber for setbacks in life.
How Much Money Should Be in My Emergency Fund?
There is some debate about exactly how much should be in your emergency fund. Ultimately, it’s an entirely personal decision. For example, someone who is in contract work or works for themselves may want to build an emergency fund that’s larger because their income stream is less reliable than that of a traditional job.
Ideally, you want to have around six months’ worth of living expenses saved up. If you lose your job, it can take you several weeks or months to find a new position. You want to have enough money saved up that you can comfortably handle losing your job or large expenses being thrown your way.
Where Should I Keep My Emergency Fund?
Ideally, you want to keep your emergency fund in a savings account. You don’t want the money locked up in investments. It should be accessible immediately to you, without penalty. You can also make your emergency fund work for you. Put it in a high-interest savings account (HISA) rather than a regular savings account so it earns interest as it sits there.
Another tip to remember is that you should keep your emergency fund in a separate bank or account from your regular accounts. If you see your emergency fund every day, you may be tempted to dip into it for nonemergency situations.
How to Start Building an Emergency Fund
It may feel overwhelming when you think about how to build an emergency fund. However, if you tackle it step by step, the process becomes a lot more manageable.
Set a Reasonable Goal
First, it’s important to set an end goal. When you know what you’re working toward, it’s much easier to track your progress.
Decide how many months of living expenses you want to save up for. Consider factors like your job stability, the amount of your previous unexpected expenses and your risk tolerance. Other variables should be considered too.
If this has been an incredibly expensive year for you, you could choose first to build up three months’ worth and then work your way up after that.
Next, calculate your average monthly living expenses. We suggest opening all your accounts and combing through the last four months. This will give you a rough idea of how much you typically spend per month. Make sure to only include the bare necessities. Then, multiply your desired months by your typical monthly expenses, and you’ll have a goal to work toward.
Make sure your goal is reasonable—if you choose an unattainable goal, you’re more likely to get discouraged along the journey.
Track Your Budget
Next, you will want to figure out a budget and stick to it. You should have an amount you want to set aside for your emergency fund every month so you can meet your desired goal.
Use an app like Mint or YNAB to track your money. That way, if you ever fall short of your goal, you can analyze your spending to see where you can cut back.
Make It Automatic
If you receive direct deposits, you can set up automatic transfers for your savings. This will allow you to regularly contribute to your goal without thinking about it. You also won’t be tempted to spend the money because you won’t see it sitting in your bank account.
Put Away Any “Extra” Money
Chances are, throughout your year, there will be times when you come into some unexpected cash. This could be from birthday presents, bonuses or tax refunds. Make a promise to yourself now that when you get this money, you will put it into your emergency fund.
Sell Something
Take a look around your home and see if there’s anything you can sell. There might be clothes, old electronics or furniture that you can get rid of. This extra income can build an emergency fund much faster (and simultaneously declutter your home).
Modify Your Expenses
Don’t feel like you need to cut out all discretionary spending, because if you budget too aggressively, you might just end up giving up on the project. Instead, choose to eliminate just one thing, like eating out. A small change can add up over the months and help you grow your fund.
And don’t forget to take a look at your fixed expenses to see if there’s room for budget cuts there too.
Reward Yourself (Occasionally)
Building up a large emergency fund will take a lot of discipline and commitment. Over time, as you put all your extra money into your fund, you might start to feel discouraged.
To avoid this situation, set up mini goals along the way. As you achieve these goals, you can reward yourself. For example, every time you hit another 10% milestone toward your final goal, you could treat yourself to a movie night or a Starbucks drink. This will help you have something to look forward to along the journey.
Use Credit Repair to Your Advantage
Credit repair has the power to reduce financial stress and contribute to your overall savings. As your score increases, you’ll be given new advantages you can use to achieve your goal.
- Interest rates. Better credit equals lower interest rates for your credit cards. If you’re now paying less in interest, you can pass the savings on to your bank account for an instant emergency funding method.
- Fees. Your budgeting app can set reminders for you so you never incur late fees again. Whatever you save in late fees can go to your emergency fund instead.
- New benefits and rewards. Individuals with outstanding credit are often given access to the best interest rates and credit accounts. They receive benefits such as frequent flyer miles, cash back and shopping discounts. You can use these perks to continue to save in new ways and build up your emergency fund.
Your Safety Blanket
Your emergency fund is a saving grace when disasters in your life occur. It might be challenging to build it up, but you’ll be glad it’s there once you have it. Make sure to clearly define for yourself what constitutes an emergency.
And, if one occurs, don’t be afraid to dip into the fund. If you do use some of the funds, restart the journey to building it back up. This way, you’re always protected.
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