Credible Takeaways
- An emergency fund is money you set aside to pay for unexpected expenses.
- Experts recommend saving 3 to 6 months' worth of expenses.
- Setting up automatic contributions can help you stay consistent with saving.
Life is full of surprises and unexpected challenges. But many people don’t have an emergency fund to cover them in the event of a job loss, health crisis, or major home repair. In a poll conducted by Money Under 30, more than 1,000 people were surveyed on their emergency fund habits, and only 23% reported being able to cover six months of expenses.
Building an emergency fund can help you prepare for unplanned situations and prevent you from going into debt. Here's how.
What is an emergency fund?
You can think of an emergency fund as a financial safety net. It’s money you set aside to pay for unexpected expenses like a vet bill or car repair, or regular expenses if you've temporarily lost your income or it's been reduced. An emergency fund can help you avoid running up your credit cards or turning to high-interest debt options like payday loans.
When should you use your emergency fund?
You should aim to only use your emergency fund when an emergency strikes. That way, it's there when you need it most. While it’s up to you to define what constitutes an emergency, some common examples include:
- Job loss
- Home repairs
- Car repairs
- Unexpected veterinarian expenses
- Medical bills
Tip
Avoid using your emergency fund to pay off debt. Instead, consider other solutions, like using a debt consolidation loan to pay off high interest debt and lower your payment.
Check Out: Debt Consolidation Loan vs. Credit Card Refinancing: How To Choose
Steps to start an emergency fund
If you’re ready to start an emergency fund, you can follow these steps:
1. Create a budget
If you don’t have a budget in place, take some time to create one. According to a 2023 survey by Debt.com, 85% of people have a budget, and there are plenty of reasons why. A budget can help you identify how much income you have to work with each month and where you’re currently spending money. If you feel like you don’t have enough money to start saving for an emergency fund, you can use your budget to identify nonessential expenses that you can cut to free up funds.
2. Calculate how much you want to save
Based on your essential expenses, and what you can afford, how much do you need to set aside each month to reach your emergency fund goal? While the number might feel out of reach, an emergency fund is something you build over time. Just by starting, you form the healthy habit of saving each month.
3. Open a savings account
To prevent dipping into your emergency fund for regular expenses, consider opening an account that is separate from the one you use for daily transactions.
Aim to keep your emergency fund in a reliable, safe, and easy to access account. Something like a high-yield savings account (HYSA) or money market account (MMA) versus investing in the stock market, for example.
Both HYSAs and MMAs allow you to earn interest on your money without the risk of losing your emergency savings due to changes in market conditions.
A savings account also provides immediate access to your money, should you need it. Look for a bank, credit union, or other financial institution that will insure your deposits through the Federal Deposit Insurance Corporation (FDIC).
4. Automate your savings
Consider setting up automatic transfers through your bank or financial institution so your contributions come out of your account before you have the opportunity to spend them. This can help you stay consistent in your savings.
5. Review your savings
Review your emergency account savings regularly. If you get a promotion or bring in more money through a bonus or side work, consider increasing your contributions. If your living expenses go up and you can’t afford your regular contributions, you can adjust accordingly.
6. Replenish your account
If you experience job loss or another emergency that requires you to dip into your funds, make sure you work toward replenishing your account as soon as the emergency clears. While you don’t want to expect another emergency, you never know what is going to happen.
7. Be consistent
When it comes to saving for any goal, consistency is key. It takes time to build a substantial emergency fund, so try to stay focused. Hopefully, the peace of mind that comes with having an emergency fund will keep you feeling motivated.
8. Reassess contributions once you reach your goal
Once you reach your savings goal for your emergency fund, you can redirect your contributions to another savings goal. For instance, you could apply more money to debt repayment or deposit that money into a retirement account, where it has the potential to earn more interest.
How much to save for your emergency fund?
The size of your emergency fund depends on what you feel comfortable with and what you can afford.
As a general rule of thumb, it’s recommended that you have enough savings to cover three to six months of expenses.
Expenses include your monthly necessities. This can be your rent or mortgage, insurance, personal loan payments, car payment, property taxes, and utilities. Your emergency fund is not meant to replace your entire budget, such as money for entertainment or eating out. The goal of emergency savings is to cover the essentials to get you through an emergency.
When you’re trying to decide how much to save for your emergency fund, consider factors like where you live, how much debt you have, and how secure your job is.
For instance, if you live in a high-cost area, have dependents to support, and worry about job security, you might aim to save six months or more of expenses in your fund. If you live in an affordable city, have no kids, no debts, and are in a dual-income partnership, you might feel comfortable with three months of saved expenses.
Try not to let the amount intimidate you from starting to save. Having something in an emergency fund is better than nothing. Start putting away as much as you can afford each month to get in the habit of saving.
Emergency fund FAQ
Should I use my emergency fund to pay off debt?
No. It’s important to have money saved in case of an emergency. Without it, you could be forced into high-interest options to borrow enough to get you through one. But once you’ve built up your emergency fund to where you feel comfortable, you can pivot to paying down debt instead.
Where should I keep an emergency fund?
Your emergency fund should ideally be kept in an account that is reliable, safe, and easy to access. For example, something like a high-yield savings account is safe and easy to access, whereas holding the money in stocks can take longer to access or could force you to sell at a loss. Look for a bank, credit union, or other financial institution that will insure your deposits through the FDIC.
What is the best way to build an emergency fund?
The best way to build an emergency fund is with consistent additions over time. Setting up automated transfers to your savings account through your bank or financial institution can help you stay on track.
