One of the most important things that you can do for your finances is to have an emergency fund.
Your emergency fund is money saved that’s meant to cover any emergency expenses that might come up.
It’s a hedge against the unexpected in life.
You’ve probably heard that you need to have an emergency fund, but like most people, you’re not sure how much you should put into it.
Or, you’re not even sure if you should save for emergencies while you’re trying to reach other financial goals.
There is no one right answer to how much you should save for emergencies, but I’ll share a few rules of thumb to get you started.
Knowing these general guidelines will give you a target to aim for.
What is an Emergency Fund
Your emergency fund is the savings account that holds funds for true emergencies.
It’s where you would draw money from in the case of an unexpected event that would require large sums of money that you wouldn’t have otherwise.
Having an emergency fund means that you don’t have to go into debt to cover unexpected expenses. This helps you avoid massive amounts of credit card debt.
Emergency Fund vs Savings
Although an emergency fund is a type of savings, they aren’t the same.
You save with the intent of one day spending those funds.
An example is a sinking fund, where you are saving for a specific thing or event and event. The money will eventually be spent.
With an emergency fund, the hope is that you don’t have to spend the money. It’s really your last resort of funds to tap into in the case of an unexpected event.
What Qualifies as An Emergency?
Beyond having money saved for emergencies, you have to understand the difference between what the money should be used for and what it shouldn’t be used for.
True emergencies are those things that are unexpected and need to be addressed immediately.
An example would be if your car engine blows and you needed to replace it in order to have transportation.
That’s something that will require you to spend a significant amount of money that you weren’t expecting at the time.
Whereas, buying tickets to a concert before they sell out is not an emergency.
Emergencies are those unexpected things that are not included in your budget for that pay period but need to be resolved.
Here are some examples of things that qualify as emergencies and things that don’t.
|Car engine goes out & needs replacing
|Routine oil change
|Vacations from work
|Routine doctor’s visit
|Cosmetic car job (painting, stereo)
True emergencies are things that aren’t anticipated. Your emergency fund allows you to have money available if those things occur.
Before dipping into your emergency fund, I recommend asking yourself these questions:
- Can this afford to wait? (Can this be budgeted and saved for at a later time?)
- Do I need this to survive? (Ex. Emergency surgery)
- Are there other options? (Can I rent a car for now?)
Know the difference between what is truly an emergency versus what is a want.
A “want” can wait, but emergencies can’t.
How much money should be in an emergency fund?
Having $1,000 put away in a high-yield savings account is typically enough to cover small emergencies that may arise. You could easily afford a car repair or a medical bill with $1,000 in your bank account.
However, you should aim to have more money stashed away after your reach this milestone.
The rule of thumb is to have 6-12 months of expenses in a savings account.
This money will cover even bigger emergencies, like layoffs, long-term disability, or major home or car repairs.
To calculate your expenses, you’ll need to first create a budget.
When you create your budget, you can see how much money you are spending for each expense category, such as food, shelter, transportation, etc.
Calculate how much is required for you to survive at a minimum each month. You’ll need to save that amount to cover between 6 to 12 months.
Where to put your emergency fund
An emergency fund can be held in a high-yield savings account.
High-yield accounts allow you to collect interest on the money that’s in your account. So, essentially, you can make money from your savings just sitting there.
Put your emergency fund in a bank that’s separate from your general checking account to avoid the temptation of withdrawing from it unnecessarily.
In the case of an emergency, you should be able to access these funds by transferring them into your main checking account—usually taking 1-3 business days or using a bank-issued card.
You should also have cash on hand in case of an emergency.
There may be instances where service providers—such as towing companies—will only take cash. You want to be prepared for these cases as well.
How to build your emergency fund
Now that you know how much you should aim to save, you have to create a plan to actually save it. Here’s how you can build your emergency fund.
- Set a financial goal for how much you want to save. Keep in mind that there is no right number. Set a goal for what you feel is enough to cover emergencies for your family and lifestyle.
- Open a savings account specifically for your emergency fund. The next step is to actually have an account that your money can go into. Figure out what kind of savings account will work best for your goals.
- Evaluate your budget and cut expenses to free up cash. It would surprise you how much “extra” money you have tied up in dining out, in unused subscription services, or that’s being spent on unnecessary items. Eliminate the unnecessary and put the extra money in your savings account.
- Automate your savings from your paycheck. Have your employer automatically deposit a certain amount into your savings account every time you get paid. This means that you don’t have to think about it and the money is put away before you have a chance to miss it!
- Find ways to make extra cash to get to your goal faster. You can sell items online or have a yard sale to make some extra cash. Put all of the profit that you make into your savings accounts and continue to add to it until you’ve reached your initial $1,000 or at least six months of expenses. Don’t forget large windfalls of money like tax refunds and bonuses.
Final thoughts on starting an emergency fund
Starting an emergency helps give you peace of mind when it comes to your finances.
There’s nothing like knowing that you have the funds to cover those unexpected events in life.
At the end of the day, having to deal with an emergency is never fun, so prepare for one to make things a lot easier.