What is an Emergency Fund?
An emergency fund is an amount of money set aside to cover unexpected expenses such as an urgent car repair, home repairs, a medical emergency, or losing your job. It is a buffer that gives you the peace of mind of knowing that you have money to deal with emergencies instead of running the risk of going into debt if financial hardship hits.
Stuff happens, cars break down, the ac goes out of commission, or you lose your job and need to pay rent quickly. Wouldn’t it be great to have a safety net? That’s what an emergency fund is for; it will save you from financial ruin.
An emergency fund keeps you out of debt during uncertain times.
Let’s take a look at what an emergency fund is not:
- It does not need to be a huge amount of money; you can start small.
- Should not use to pay for shopping, vacations, or home renovations.
- It should not be used to pay off debt or for planned purchases like buying a car, a house.
- You need to be able to access the funds quickly, so your emergency fund is not your collection of hockey cards, your house, or your car.
Why is it Important to set up an Emergency Fund?
The purpose of an emergency fund is to have a financial safety net that allows you to pay for emergency expenses should the need arise; yet, according to a 2019 study, 40% of Americans don’t have enough cash to pay for an unexpected expense of $400. More and more people are relying on debt.
The issue is people do this in reverse. When a crisis comes, they get into debt, and then they spend years paying back the debt plus interest. With a “rainy day” fund, you’re paying yourself first; when and if a crisis comes, you’ll have the financial means to get through the difficult time, and you won’t be stuck paying credit card bills forever.
Know this – if you do not have an emergency fund, you’re setting yourself up for financial hardship. Even if this means cutting back on expenses, set some money aside for unexpected events.
Once you have some money stashed away, don’t spend it; forget about it for a while. In times of need, you’ll be glad to have the extra cash.
Make sure you can distinguish between emergency money from everything else. Some banks allow you to label sub-accounts according to your saving goals. By labeling your emergency account as such means, you won’t mix spending money with the emergency fund. However, make sure you’re not paying duplicate monthly bank fees.
How to Build an Emergency Fund
Find out how much you need to save and set up a monthly saving goal. For an easy way to find out how much to save, use MyHomeAnswers’ emergency savings calculator below. Then set up a monthly saving amount.
Set up automatic transfers. Ask your bank to automatically deposit money to your savings account every time you get paid. Automatic transfers make it easy to save money, which gives you a chance to build a good rainy day fund.
Sell things you don’t need. You’ll be surprised to find out how much you could get by selling things you no longer want on Facebook Marketplace, Craigslist, or by hosting a garage sale. That pile of cash can go directly into your emergency fund.
Save your tax refund, bonus, or other lump-sum payments you receive. When you receive this money, consider redirecting funds directly to your emergency fund. It is an easy and fast way to boost your emergency cash.
Get a side gig. You don’t have to leave your home to make extra cash, so this is a great way to save for a rainy day.
Reduce your expenses. Simply by cutting expenses such as daily lunches, dinner outings, or monthly subscriptions like a gym membership, you could save hundreds of dollars per month and allocated that to your emergency fund until you’ve saved the amount you want.
For some nifty ideas on how to save money, check out our Saving Budget Calculator.
Build a basic spending plan. This means creating a budget plan. Think about spending on essential items only such as rent/mortgage, utility bills, gas, phone bills, groceries. During a crisis, you want to protect your home and your livelihood above all.
Emergency Savings Strategy for Couples
For families where both partners earn income, the best way to save money is by adjusting your spending to depend on one income while using the second income for sayings, including emergency funds, sinking funds, travel funds, etc.
All that it takes is discipline.
When my wife and I got married, we decided I would pay for all expenses in the house while my wife’s income went into joint savings accounts, one of which was an emergency fund. I must admit, the one area where we did indulge was travel, so we had a separate travel fund.
Using this method prevents you from living beyond your means. You learn to live on one income while using the second income for savings and fun. It works!
How much should I save?
You should save enough to cover 1 – 6 months of your income. For families with two incomes, three months of income is sufficient, but for single-income households, you want to have savings of at least six months’ worth of expenses.
The Bureau of Labor Statistics reports that the average time to find a new job is about 17 weeks. That’s roughly four months, but people might find themselves unemployed for even longer.
If your monthly expenses total $4,000 per month, that means you need anywhere from $4,000 (one month) to $24,000 (six months) as an emergency fund. However, the important part is to save money for unexpected expenses, even if that means saving $1,000 or $500.
Start small and build from there.
For higher earners, if you suddenly lose your job, unemployment benefits may not be enough to sustain you. You don’t want to be at the mercy of the government because that won’t be enough to save you from experiencing financial hardship.
Where to Keep Your Emergency Fund Money
When a financial emergency arises, you need quick access to funds. This means for most people, the best place to keep emergency money is in a savings account. Using emergency money to buy stocks or bonds wouldn’t be wise because you could lose it, especially during a crisis.
Also, let’s not forget about inflation. Saving accounts typically pay under 2% interest, even high-interest accounts; that’s not enough to keep up with inflation.
Another good option for where to keep your rainy-day fund is short-term deposits, CDs, or GICs, where you get a guaranteed interest rate. If you need to withdraw the money before the term is up, you forfeit the interest, but the principal is kept safe from market volatility.
When it comes to emergency money, safety trumps risk, so choose an account where you know the money will be there for when you need it most.