We all experience costly, unplanned expenses from time to time—a broken appliance, an auto accident, a surprise medical bill, a loss of income. Having a dedicated emergency fund can not only provide the reassurance you’ll be able to meet unanticipated financial needs, it’s also one of the first essential steps you can take to start saving. Putting even a small amount aside for emergencies can help you recover more quickly and get back to meeting your financial goals that much faster.
In this guide, we’ll explain how to build your emergency fund, how much money to save in your emergency fund, where to put your emergency savings, and when to tap into it.
An emergency fund is a dedicated savings account specifically set up as a cash reserve to cover unplanned expenses and financial emergencies. Some common reasons for tapping into these funds include unexpected medical bills, car and home repairs, or job loss. Generally, emergency savings can be used for any unforeseen bills or payments not part of your routine monthly expenses and spending. Emergency savings differ from savings set aside for leisure travel, holiday gifts, down payment for a home or car, and other large expenses which are typically planned for ahead of time.
Without savings, a financial setback could turn into debt and potentially have a lasting impact on your financial outlook. Relying on credit cards, loans, or other savings, like retirement accounts, to cover emergency expenses can lead to debt that may be hard to pay off, or decrease your future financial security.
Emergency savings can pay for unplanned or emergency costs and spending outside of your otherwise routine monthly bills and expenses. For example:
The amount of money you have in emergency savings will vary depending on your income, the rate at which you’re able to save money, and your other financial obligations. Being laid off would be a major financial emergency for most people. To cushion against this, experts generally advise saving enough in your emergency fund to cover between three to six months of your essential living expenses.
You might need to save more than this if:
Keep in mind that essential living expenses generally excludes discretionary spending such as streaming subscriptions, new clothes, tickets to sporting events or concerts, travel, or dining out. Essential expenses are the bills you must pay every month, such as:
Depending on your current income and debts, setting aside three to six months worth of living expenses into an emergency savings account could be challenging at first, especially if you’re already on a tight budget.
To build some momentum for saving, start by setting a small savings goal you can easily reach and increase your goal amount as you progress. For example, what was the last unplanned expense you had difficulty paying? If paying a $300 dental bill was a struggle before, set an initial emergency fund goal of $300. Once you reach that goal, set a bigger goal, and so on.
Next, examine your current budget (or create a budget if you don’t have one) and spending habits to find areas where you can cut back. Put that money toward your emergency fund. Some expenses to consider forgoing for a while might include entertainment (restaurants, concerts, sporting events), subscriptions (streaming services, wine or food delivery memberships), and travel.
Squeezing extra money out of your budget isn’t the only way to build your emergency fund. You can also try:
Automating your savings can help you build your emergency fund. For example, you could schedule an automatic transfer from your checking account to your savings account right after you get paid. Some employers could directly deposit your paycheck into two different bank accounts. This keeps the money from hitting your checking account, so you won’t be tempted to spend it.
If you’re a freelancer or have inconsistent income, instead of automating transfers (which may leave your checking account short of funds), you might try designating a certain percentage of every deposit—say, 5% or 10%—into your emergency fund.
When choosing the type of account for your emergency funds, consider easy to access, interest-bearing savings or checking accounts. Generally, unless there are additional associated fees, the account should be separate from your already established accounts, such as a vacation savings account or a regular checking account used to pay your monthly bills.
Earning interest on your emergency savings is another important consideration, and the type of account you choose can affect those earnings. Generally, high-yield savings accounts or money market accounts offer a higher annual percentage yield (APY) than regular savings accounts. These types of accounts typically are also easy to access when you need to make a withdrawal.
However, depending on your financial habits, it might be helpful if your emergency funds are not too easy to get to. To create some friction, consider establishing an account at a different bank than where you have your regular checking or savings accounts. Confirm how long it takes to transfer money from one bank to another in case you need to withdraw funds quickly.
Before selecting the type of account for your emergency savings, be sure you know the answers to the following questions:
Reserving your emergency fund withdrawals for only urgent, unforeseeable expenses is essential. However, set some realistic, consistent guidelines. Not every unplanned expense will be an emergency, but don’t be afraid to tap the funds should you need to. For example, when paying now for preventative measures on your home or car will help you avoid more costly repairs or replacement in the future. Also, having emergency savings can help you avoid relying on high-interest credit cards or other forms of credit that may lead to debt and cost you more in interest and fees over time.
As your emergency savings grow, it may be tempting to tap these funds for non-urgent, discretionary expenses and spending, such as a down payment on a new car. Instead, plan ahead to save separately for this and other financial goals by setting up or designating different savings accounts for different purposes.
If you’ve accumulated revolving high-interest credit card balances or other debt, is it better to pay down that debt first before putting money into emergency savings? While the average interest charged on outstanding credit card balances far outweighs the interest you can earn on the average high-yield savings account, without an emergency fund, it could push your credit card balance (and cost of borrowing) even higher, and possible at higher rates.
Generally, it’s helpful if you can allocate some money toward debt repayment, and some—even if it’s a small amount—toward establishing emergency savings. As you begin paying down your credit cards, you could start to accelerate your savings by redirecting the money you previously put toward credit card debt toward your emergency fund.
Setting aside at least three to six months of essential living expenses into an interest-bearing savings or checking account for unplanned financial emergencies is an important first step toward saving. Even if you’re already on a tight budget, setting aside even a small amount into an emergency fund can help you recover more quickly, help you avoid more credit card debt, and get back to meeting to your financial goals that much faster.
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